With global quantitative easing now getting long in the tooth, I think the party is about to end for the Treasury bond market. For the last four months, this market has been stuck in a tedious, narrow range, with ten year paper stuck between a 1.90% - 2.10% yield. Trading bonds has been as exciting as watching paint dry, with only professionals able to engineer profitable round trips. The charts below show that we have at last broken out of that range.
Private US investors and foreign central banks are not going to be able to make up the shortfall in bond buying once the Fed and the ECB exit the stage. The big problem is that the bond market these days is very much like a Ponzi scheme. Unless there is a steady inflow of new suckers, the entire plan collapses like a house of cards.
I can’t tell you how many hedge funds are itching to short Treasury bonds. Thousands jumped in too early last year only to get their fingers burned, myself included.
The ideal instrument for the individual investor to get involved in this market is with is the ProShares Ultra Short 20+ Treasury ETF (TBT). I have included a three year chart below to show you what the long grinding bottom looked like. The only surprise is that it took this long to turn up, given the strength we have seen in risk assets since October.
Keep in mind that the cost of admission to play this game is high. A 200% short bond position means that you are short the coupon twice. For a 30 year bond with a 3.4% yield, that adds a cost of carry of 6.8%. Add in another 1.2% for management fees, expenses, and other hidden costs, and you really need Treasury bonds to fall 8% year just to break even in the ETF. You won’t ever see the interest and fees deducted. It just feeds directly into the ETF price. On top of that, you can expect some tracking error. That’s why it is best to catch only the short term pops in this security, much like you have seen this week.
Of course, I hate buying anything that has just popped 10%. You know me, I am not a chaser. Ideally, the long awaited 5% correction in stocks will create a rally in bonds and a selloff in the (TBT) that could provide a prudent entry point.
If this really is the end of the 30 year bull market, there is a lot of room on the upside for the (TBT). Take 30 year yields back to last year’s high of 4.2%, and the (TBT) nearly doubles to $40. If the markets want to finally pay attention to our large and ballooning budget deficits, now over 100% of GDP, it could deliver a multiple of that.
Is the Fat Lady Singing for the Treasury Market?