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So bearish on Treasury bonds just a few weeks ago at yields 70 basis points higher, growing...

So bearish on Treasury bonds just a few weeks ago at yields 70 basis points higher, growing numbers of bond managers now posit the 10-year could fall to 1.5% (currently 1.74%). "Fundamentals are out the window at this point," says Matthew Tuttle, who last week jettisoned a lot of stocks and high-yield paper from his portfolio to buy Treasurys. Cycles, gotta love cycles.
Comments (4)
  • Looks like everybody is getting on one side of the boat,,,
    21 May 2012, 08:00 AM Reply Like
  • Eurobonds + Greek Exit + Spanish credit crunch = 10 Year @ 1% by election day.
    21 May 2012, 08:37 AM Reply Like
  • Someday TBT will be the stock of the decade. Not soon however. Not until after the elections.
    21 May 2012, 08:48 AM Reply Like
  • These comments refer to the PST symbol ETF, which is 2x short a 7-10 year treasury index. Theoretically that sounds like a reasonable vehicle, but I was worried about the execution and the carry costs. So I ran a model fit for the change in price of PST against the change in the quoted yield on the US 10 year as reported by Yahoo Finance.

     

    The fit returns with an R squared of 0.914, that is, the change in the yield on the 10 year explains over 91% of the variance PST price.

     

    The slope of the fit line is 13.5 - that is the effect of the 2x leverage and "futuring" on a mixed index with some 7 and some 10 year etc. Note that the actual duration of a 10 year right now (assuming a 2% coupon) is about 9.13, so the effective leverage is about 1.5 times vs the 10 year, even if they are aiming at 2x vs the index (that includes some shorter notes etc).

     

    But the fit line also has an intercept, with a negative sign, corresponding to just under 4 basis points a day of "bleed" or carry cost. It annualizes to negative 9.1% per year.

     

    This ETF has a 0.95% expense ratio, though currently it is being waived by the manager through September of 2012. Being short with leverage involves carry costs. There are also futures related costs from rolling front months, and transactions costs. All combine into that negative average daily 4 basis point "bleed".

     

    If this fund earns 13.5 x the change in the 10 year yield minus 9%, as this fit predicts as a reasonable model of what it has been doing, then the 10 year rate needs to rise to about 2.4% in the coming year just to break even. Considering the risks run (-60% over the last 4 years as treasuries continued to rally strongly against expectations) and the 4-5% available on corporates on the long side, you need to believe that rates are nearly certain to rise 1% a year or more, with a rise of 2% about as likely as rates remaining flat.

     

    Personally I think expecting rates to *eventually* rise 2 to 2.5% on the 10 year to the 3.75-4.25% level is a reasonable bet, but that "eventually" is probably 3-5 years, not "next year". And a 9% headwind is just not something I can justify at all, in that context. Or any other, really...
    23 May 2012, 07:28 PM Reply Like
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