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For years
now, US government bonds have looked like terrible investments, what with
those trillion-dollar deficits and multiple wars and all. But Treasuries just
kept rising, earning their owners nice returns and making their critics seem
like financial illiterates who didn't know a AAAA
credit when they saw one.
Check out the
chart for TBT, a 2X negative long-term Treasury ETF (in other words, a fund
that bets against Treasury bonds). In case the price numbers are hard to
read, this fund peaked at 70 in 2008 and has since fallen steadily if
irregularly to less than 20. Far from being the short of the decade,
Treasuries, especially if you were using leverage to bet against them, have
been a sound-money investor's nightmare.
But two
things are true of bubbles always and everywhere: They tend to go on longer
than a reasonable analyst believes possible. And they burst when fundamentals
finally win out. Treasuries will go the way of all bubbles someday and, just
maybe, today is that day.
The eurozone can has been kicked way
down the road and the US economy seems to be improving, which lessens the
urge to hide in safe havens. Risk on, in other words. And today Treasuries
got absolutely smacked, with TBT jumping by 5%, a huge move for any bond
fund. Here's a take on the market action from Forbes:
Treasury
Market Exuberance Leads To Violent Sell-Off
A violent
Treasury sell-off began after Tuesday's FOMC statement, as bond markets
reacted to an improved economic environment, a more optimistic Fed, and the
reduced possibility of QE3 in the immediate term, at least for now. While
Treasuries appear to be more "fairly" priced, according to Nomura,
the possibility of a flare up in Europe, along with a worsening of the
domestic outlook, could see fearful investors jumping right back into
Treasuries.
Yields on
10-year Treasuries finally broke free from a tight trading range and jumped
to 2.27% by 2:50 PM in New York on Wednesday, hitting their highest levels
since October.
The trigger
was Tuesday's FOMC statement, where the Fed acknowledged an improvement in
labor markets, the continuing economic recovery, and the temporary uptick in
inflation (on the back of rising oil prices). Shortly after the Fed
statement, JPMorgan said in a press release it had passed the stress tests
with flying colors, prompting the bank run by Jamie Dimon
to announce a dividend hike and a big buy-back.
Jamie Dimon's ratification that the economy is indeed better
was the final straw, exacerbating the sell-off, according to Barclays. As
market players factored in the diminished possibility of a third round of
quantitative easing, along with the increased possibility of a rate hike
coming earlier than expected, Treasuries plummeted. Gold fell in tandem while
the U.S. dollar rallied.
"A new
dynamic has been set in motion [as] complacency was widespread,"
explained Nomura's fixed-income strategist, George Goncalves.
USAA's Didi Weinblatt, VP
of mutual funds and a fixed-income expert, added that "rates were
artificially low," helping make the move that much more violent.
"Everybody that was riding with the Fed got out at the same time,"
she added.
Weinblatt warned that markets remain schizophrenic, oscillating
between risk-on and risk-off on any headline.
Fundamentally, she believes, rates should be a lot higher, but "the Fed
is still doing the Twist, Bernanke has QE3 in the backburner, and Europe
could still flare up," once again sending investors scrambling for the
safety of Treasuries.
Nomura's
strategists believe Treasuries are now closer to "fair value," and
have a medium-term target of 2.4% for 10-years. While most bond sell-offs
start this way, and yields "had no business staying under 2%," a
worsening of the domestic or global environment could dramatically change
things in a very short time frame, as Tuesday's price action illustrates.
Is this the
turn for Treasuries? Well, they're certainly not "fairly valued" on
fundamentals. The long bonds of any country with government debt and total
debt exceeding, respectively, 100% and 350% of GDP are an automatic short,
just on simple math. But the US, as the printer of the world's reserve
currency, is a special case in terms of timing. When trouble strikes
elsewhere, people still come here to hide. So even in the face of ridiculous,
Greek-like numbers, the dollar continues to function as money and Treasuries
continue to find a bid.
There will
come a time when shorting Treasuries is the trade that makes fortunes and
reputations just as surely as did shorting mortgaged-backed bonds in 2007.
But as with any other bubble, it's best to wait until the market shows clear
signs of cracking before jumping in with both feet. Time will tell whether
today's action is that kind of sign, but when such a sign does come, it will
look a lot like this.
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