I am very bearish on U.S. Treasuries, and therefore, bullish on interest rates. Eventually, the ECB and the BoJ will end their QE programs. Then interest rates will no longer be pressured downwardly. At the same time, with the U.S. economy expanding, the Fed will continue to push up interest rates. Those two items alone will push up interest rates. However, there may be something else more glaring that traders have missed: Treasury International Capital, or TIC, data is showing a net loss of foreigners selling U.S. treasuries.
The BoJ and the ECB are two 800-pound gorillas in the room. They are pressuring longer-end interest rates lower. Eventually, with the end of their QE programs, this pressure will end. Interest rates may go through the roof.
At the same time, with the economy expanding as it is, interest rates have every reason to move higher, as they have been doing. The Federal Reserve signaled it intends to continue to raise interest rates. I believe the Fed to be behind the yield curve. Using generic analysis, unemployment is at 4.7% and has been for some time. There is firm job growth. There is inflation of 2.7% headline with near 2.0% core. There is wage growth and personal consumption of of 4.7% and 3.8%, respectively. And short-term rates are only 1.00%.
Then there is the TIC data. Foreigners are net sellers of U.S. treasuries. This has been going no on over the past year, and has largely been missed.
The only reason I can tell that longer-end government yields are not already above 3% is that the BoJ and ECB are pressuring rates lower, as they have been. Take those two out of the equation, and interest rates move up sharply. Factor in that these two entities are either tapering their programs or will be ending them entirely by the end of the year, and you suddenly remove what is keeping rates at bay.
Then there is another factor to keep in mind: The Fed's balance sheet. Amid all of this — net foreign sellers, economic expansion that will push down bond prices, the removal of the two central banks — you have the balance sheet of the Federal Reserve. And let's face it, the Fed does not have a whole lot of experience in shrinking its balance sheet by 80%.
The Fed ran up its balance sheet from 2008, when it was $800 billion, to $4.5 trillion in just a couple of short years. By removing the balance sheet, even if they just let the assets expire off the books, that alone will have an effect on interest rate levels.
There are far too many variables at play right now with regard to interest rates and what could push them upward. Adding in the net effects of foreigners selling their assets, and it becomes a question of "how high is high" when you think about interest rates.
I have been bullish on interest rates. The evidence continues to mount as to all the reasons they are moving higher. I have been selling into the market whenever we see a move upward in bonds.
I am taking a significant position short bonds and holding for a longer trade. I have been getting in and out over the past several weeks, bringing in a quick 1% off of the moves. However, this could be a move that pushes rates far higher than imagined. I want to take advantage of this move. That is going to require an extended stay in the trade.
I am selling bond calls and buying puts. Delta will be about 25/30, respectively. Theta will be about 90 days. Vol will be equal. The trade should go for even after bid/ask on the calls over puts.
Disclosure: I am/we are short U.S. TRESAURIES.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.