Treasuries Get Silly Sparking Bubble Talk

Posted by urbandigs

Tue Dec 9th, 2008 10:07 AM

A: The 30YR Treasury Yield fell about 113 basis points in the last 4 weeks alone. The move, highly similar to the silly parabolic move that ends up characterizing the final phase of a bubble, was sparked by 'Bernanke talk' that the fed may wind up purchasing longer term treasuries. I've discussed this treasury bubble talk a few times here on UrbanDigs, as I always like to look ahead - even if that means way ahead. But don't forget the words I associate with any treasury bubble; 'endgame', 'multi-year train of thought', '5th or 6th chapter to this slowdown', and 'final stages of secular bull market in treasuries'! Lets discuss.

Please note that when I discuss something that I see as likely down the road, that doesn't mean you go and put a trade on immediately; this site is an open forum not investment advice on equities! But I often discuss trading markets outside of Manhattan real estate, so content here will be mixed. As a trader that likes to find good entry points, sometimes timing is wrong and you have to make the decision to bail and start over. The short the long end of the curve trade is just that, I was very wrong on timing, and I hit my stop losses on TBT/PST about 12 trading days ago, and been watching since. The final stage of any bubble is the 'silliness' stage when the asset takes off, so to speak, just as the bubble talk gets going. The dot com's did it, housing did it, oil and other commodities did it, and now treasuries seem to be doing it. But the end result is usually the same.

Think back to oil for a moment. When crude passed through $100/barrel, the bubble talk already started. Those shorting oil at that phase had the right idea but the wrong timing and likely couldn't bear to watch the price of oil spike quickly from $100 to $145 from May to July. That 45% rise in two months time was the silliness that topped off the bubble in oil, before the burst sent the commodity plunging. From a trading perspective, identifying the bubble is one thing, putting on a huge position immediately is another. Most bubbles get a bit parabolic in the final stage, and oil was no different.

Back to treasuries. Here is what I said about the timing of any treasury bubble:

"Stages of Slowdown & End Game" (Oct 28th) - STAGE 10 (Yet To Come, End Game) - Treasury Market?: massive treasury issuance to fund bailouts, nearing the end of rate cut cycle which is yet to come (I'll bet on 75-100 more bps of easing), stabilizing economic data which is far off, unwinding or slowing of treasury purchases by foreigners, rolling over of treasuries, selling of widely owned treasuries for this slowdown, and most of the damage done to equities already may all contribute to the selling of treasuries. The treasury market is arguably at the tail end of a 20 year secular bull market. What will treasury buyers demand in yields 12-24 months from now? Will treasuries still be in huge demand, as they are today, right in the center of the crisis? The end game may bring with it the end to the secular bull market in treasuries and higher yields; especially in the longer end of the curve!

NOTE: 'what will treasury buyers demand in yields 12-24 months from now?'...not today, not a month from now, in 1-2 years! That is what I mean by talking about the bubbly market that has not reached its peak yet.

"A 'New Age' Slowdown Could Pop Treasury Bubble" (Oct 14th) - . If the long end of the curve does pop, and treasury yields spike down the road, think about how that will affect borrowing costs for businesses and lending rates for homebuyers/consumers. This may be a side effect of the massive medicine we took to combat this new age slowdown, is a multi-year train of thought and yes, it is worth discussing on a real estate blog. It could be the 5th or 6th chapter of the nationwide housing slowdown as affordability restricts with higher borrowing costs. Time will tell.

NOTE: 'is a multi-year train of thought and yes, it is worth discussing on a real estate blog. It could be the 5th or 6th chapter of the nationwide housing slowdown'...a multi-year train of thought meaning something to consider for the next few years, not now!

Sure, I had a position in TBT/PST because there were a number of occasions where yields were moving opposite of equities (rising when stocks got murdered), and some treasury auctions went badly. I thought the market may have been signaling something. I was wrong, the position went against me, and I ultimately hit it out at a loss. Fine, happens all the time. As a trader you can have the best trade ideas imaginable, and yet the position will go against you. Shorting oil at $115, in theory was a great trade. But if you couldn't take the ride up to $145, and hit it out at $130 for a loss, it turned out in hindsight that your idea was right but your timing a bit off. Live to trade another day; minimize your losses, maximize your gains.

With the big move in treasuries over the past few weeks, Merrill's David Rosenberg discusses "Treasuries In Bubble Phase, Merrill’s Rosenberg Says":

Demand for Treasuries has reached the ‘bubble” phase seen among technology stocks in 2000 and real estate six years later, according to David Rosenberg, chief North American economist at Merrill Lynch & Co.

Even though Treasuries have entered “overvalued territory,” yields may fall further and remain near record lows as the Federal Reserve, households and institutional investors increase purchases as the economy worsens, Rosenberg wrote.
Bubbly phase, meaning the silliness likely started and it will probably last longer than you think! My concern is not for today, its not for next month, and its not even for next quarter. It is for endgame, which to me is the period of time AFTER this credit crisis where some of the problems resulting from the measures taken to stem the crisis start to appear. If there is anything I learned from trading, its that bubbles tend to pop fast & furious; like oil did. If there is a bubble in treasuries, and if it does deflate later on (who knows what may spark it), rates can certainly rise very fast in a short period of time if their is a mad rush for the exits. I think this is something to worry about mid/late 2009 and 2010 as part of endgame. I wonder how beaten down the economy is at that time and if higher treasury yields equate to higher borrowing costs across the board. It may be an unintended consequence of a bubbly market, as the fed monetizes the debt by purchasing longer term treasuries; perhaps because this is the last of the ammunition left in the feds arsenal. This will make all those printed dollars that were dropped from the helicopter, actually hit the ground and enter the system. This could mark the top of the dollar deflation run.

In this piece, "Fixing the Monetary Unfixable", Nicholas Jones discusses:
"I've been saying for some time now in B&B that when the Federal Reserve and U.S. Treasury begin to monetize the debt we will know the bond bubble is near its bursting point.

First of all, monetizing debt is when the U.S. Treasury creates the government bonds and the Fed simply prints money to buy them. The destruction of the domestic currency that ensues is obvious, and in this case would be astronomical considering the amount of debt that would need to be monetized in order to sustain the U.S.' massive budget deficit.

With all of the recent bailouts, and more to come, the government has gone further into the red than it ever has (understatement). It is going to have to finance a massive amount of new debt as well as roll over old debt. Obviously the government would like to finance that debt at the lowest possible rate of interest; enter Federal Reserve stage to add artificial demand to these markets resulting in lower interest rates."
Well, right now demand for US Treasuries is no problem at all! The question is whether it is maintained at these levels. Time will tell, and I still think this is going to be one of a few chapters of the endgame story.


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