Does it make sense to own LT T-bonds right now?

[tjt]

The idea of T-bonds is that the value goes up when rates fall, and the value drops when rates go up.  But when rates are close to a theoretical low, and with the announcement of low rates for a few years, is there any upside?

Since I don't yet own any long-term T-bonds, does it make sense to buy in now?

[Storm]

You should probably take a look at Japan's "lost decade" (more like lost 2 decades) and see what happened to their long term bonds.

[Storm]

One more thing to note, tjt:

If you were to come to me and ask:

"Storm, should I buy gold right now?"

-or-

"Storm, should I buy long bonds right now?"

-or-

"Storm, should I buy stocks right now?"

I'd say to you:

"You shouldn't buy any one asset in isolation.  You should buy certain assets (Stocks, Gold, and Bonds) in equal parts in order to hedge your portfolio against any possible economic environment."

People are always saying "treasuries suck, you only get 4% yield," or "gold sucks, it's just a barbarous relic dug out of the ground."  If you tell me any one asset sucks, I'd say "you're right", but when you purchase them together, they correlate nicely with each other.  That is the beauty of the PP.

[mandynshane]

Storm- what happened to long term treasuries in japan's  "lost decade"

[moda0306]

mandynshane,

The yields dropped tremendously, currently at less than 2% on 30 year bonds if I'm not mistaken.

Long-term treasury bonds are basically the only asset you can count on to give you a decent return in times of deflation. 

[mandynshane]

Do you think we will have deflation? Ive been leaning towards inflation because Ben Bernanke and the Famous Helicopter speech.. Just think he will do anything to prevent deflation.

[moda0306]

The thing is, Bernanke, to me, is pushing on a string now and can do no more, as printing money is simply "trading a CD for cash" and there seems to be no crowding out of private borrowing... people simply are deleveraging now with suffering balance-sheets and that is deflationary, even if natural resources continue to get more expensive... the only thing that could create wide-spread (including wages, rents, housing, etc), high inflation right now, IMO, is massive deficit spending.

That doesn't look like it's going to happen.

It'd help to find our comparisons to Japan on previous posts... the similarities are eerie.

If you're thinking 1970's style inflation, realize that our populace was much-more in a position to bargain its way into higher returns.  We had willing borrowers, because our balance sheets were solid at that time.  Now ours aren't, and the supply of loanable funds is much higher than the demand for debt.  We had solid unions back then, who could bargain for higher wages in the face of higher oil prices... today we're competing with China's $5 per day workforce.

It's a very different world, I think... there are those who disagree with me though... best to hear all sides.

[mandynshane]

thanks I agree love to hear opinions...  really all Ive been hearing is inflation, so your perspective is helpful I guess I need to do some reading on Japan

[moda0306]

mandynshane,

There's some REALLY good debates and reading on here in previous discussions... maybe search for key words of the following:

MMT
Japan
Liquidity Trap
Credit Expansion
Demographics
Weimar

I'm sure there are more, but it's hard for me to think...

You'll walk away from these with a much better feel for macroeconomics, even if you still stick to your inflationary guns.  I think we have some of the most diverse, yet fair thinkers here and the debates are truly amazing to see when a lot of people begin to give their input.

[Gumby]

Mandynshane, in addition to what Moda said, here's an excellent lecture from Richard Koo on why we have contracted Japan's economic disease — which he calls a 'Balance Sheet Recession'...

http://youtube.com/watch?v=OWGDWYB5KZ0

(Hint: Flip the resolution to 720p or higher to see the slides clearly)

You can also flip through the slides here.

Some striking similarities between our two countries.

[Storm]

Mandynshane, I think what is happening right now, the US government has injected 900 billion, the Fed has injected 600 billion, and there have probably been numerous other smaller stimulus type events.

But the real issue is that we are dealing with approximately $7 trillion in housing equity destroyed from 2005-2010 alone.  That doesn't even count the additional several trillion destroyed since then.

I think MediumTex came up with the analogy of Ben Bernanke standing in front of a tidal wave with a fire hose.  This is really the best analogy I can use to describe it.  When you are dealing with $trillions of lost equity, you can't just fly a helicopter throwing out $billions.  It will never work.  Historically, there has never been a financial bubble that has been reinflated after it has burst.  It would take such an extreme amount of money that it would equal all the money available in the world, and then some.

That's why what we seem to be going through in the US and the world as a whole is what is called a balance sheet recession.  All households are realizing that their balance sheet actually reflects a lower net worth than they thought they had, so they are adjusting their expenses accordingly.  You can throw money at the problem, but unless that money creates jobs and gives households more income, there will be no inflation because there is no increased income to cause it.

Inflation only occurs when incomes increase.  Once incomes start to increase and employment starts to increase, then we'll worry about inflation.  I think we are a long way away from that.

[RickV42]

Storm - great summary to which I agree.

To officially add my two cents to the debate:  We are in or are headed for deflation as defined by the contraction of the money supply with the definition of money including credit.  

Monetary injections are going into a black whole of losses, defaults and credit contraction - which dwarf the injections (Medium Tex's firehose into a tidal wave), resulting in a NET money contraction.  The only way to get out is to clear the bad debt (or soon to be un-payable debt) through default or perhaps high/hyperinflation at some point.

Assets falling in value, high gold, low yields, banks mired in losses (if they did real accounting and marked to market), banks not wanting to lend (they spent it all already) and entities not wanting to borrow (as asset prices are going down, or they already have too much debt) are all symptoms of deflation.  Oil, food are going up, yes, but price increases are driven not only by money supply, but product supply and demand, and not all prices rise/fall at exactly the same rate.

I think the thought we can easily hyper-inflate out of this mess is everybody’s wish.  Not many are prepared for deflation, which is probably why it is going to happen.  Everyone has forgotten the consequences of too much debt.

Of course I could be totally wrong….

[MediumTex]

The key is not to build an airtight case that deflation WILL be the dominant theme for many years; rather, the key is to understand that the deflation scenario COULD occur and you would want to be protected if it did.

Long term treasuries offer this protection, and a bond that pays 3.75% today can look like an amazing investment if LT rates were to fall to 2%, as they have in Japan, or even to 3%, as they have in Germany.

[doodle]

30 year bond auction demand yesterday was apparently pretty poor. This might have been because upside market action peeled off the buyers....I don't know. My track record with 30 year bond predictions has been pretty dismal. Nevertheless, I am going to hold my 5 year ladder until we get a climb in rates back to the mid to low 4's.....even if it takes a year or two.

NEW YORK (Dow Jones)--A two-month streak of solid Treasury auctions hit a wall Thursday as a broad distaste for low-yielding long-dated bonds forced primary dealers to buy a major bulk of the afternoon's 30-year bond sale.

The $16 billion auction had the lowest level of indirect bidders--a strong gauge of foreign interest--since February 2008, hinting at both a distaste for ultra-low yields and central banks' reservations about locking themselves into longer-term U.S. government debt. The hesitance toward buying long bonds was reflected in indirect bidders taking just 12.2% of the sale. That is significantly lower than the 39.1% recent average. Primary dealers--a group of buyers that are required to take any leftover securities--had to purchase nearly half the offering.

The poor overall results come in stark contrast to the well-bid three- and 10-year sales Tuesday and Wednesday. Those were strong because there is still a healthy underlying bid for U.S. government debt, which is still considered the world's financial safe haven.

Though investors remain wary of the economic outlook, Thursday's auction dropped off because they didn't want to be stuck holding such low-yielding paper for a long time. The 30-year bond was offering just 3.60% heading into the auction, the lowest level since last September.

"It was quite horrific," said John Canavan, fixed-income analyst at Stone & McCarthy. "Not only were indirect bids nearly non-existent, but dealer bidding wasn't anything special either." Canavan said the pre-auction yields were "far too low" by historical standards to garner significant interest.

Treasury prices stuck around session lows in late-afternoon trading, with 30-year bonds leading the sell-off. They declined 4 28/32 in price, pushing yields up nearly 25 basis points to 3.784%--the largest leap since July 1996. Benchmark 10-year notes followed suit, falling 1 12/32 in price to yield 2.333%. Shorter-dated notes remain well-anchored as a result of the Federal Reserve committing to keep interest rates lows through at least mid-2013. Two-year notes were just a fraction lower in price to yield 0.184%. The session was the first decisive sell-off this week.

It isn't just historically low Treasurys yields that curbed investors' appetite for longer-dated U.S. debt. Foreign interest in the 30-year bond has been trending downward over the past nine months, something some traders say is being exacerbated by last Friday's U.S. credit downgrade by Standard & Poor's. Indeed, indirect bidders were easily outbid by direct bidders in Wednesday's auction.

"If I'm Japan or another foreign [player], I'm assessing what another downgrade might mean," says Kevin Giddis of Morgan Keegan, referring to fears that Moody's Investors Service and Fitch Ratings might follow in S&P's footsteps. "Foreign central banks need to assess their position on the U.S."

A somewhat better-than-expected drop in weekly jobless claims numbers Thursday also added to the selling pressure, giving investors hope and sending stocks higher at the expense of Treasurys. The report was a welcome change to some of the recent gloomy data that have led the Fed to acknowledge that the country's recovery is moving along at a frustratingly slow pace. Before Thursday's sell-off, the flight into Treasurys had dragged 10-year yields as low as 2.033% Tuesday--the lowest in history.

The drastic market movements also led Goldman Sachs to lower its forecast on bond yields across several major economies, including U.S. 10-year notes, which the bank sees yielding 3.0% instead of 3.5% by year-end.

David Coard, head of fixed-income sales and trading at the Williams Capital Group, said that the market felt "a little overbought" after Wednesday's session and that investors "have been projecting more economic weakness than what's really out there."

US Swap Spreads Tighten
U.S. two-year swap spread, which measures the differential between the two-year swap rate and two-year Treasury yield and is a main gauge of credit risks, was 0.75 basis point tighter at 24.50 basis points. The 10-year swap spread was 4.75 basis points tighter at 15.75 basis points.

  COUPON  ISSUE    PRICE      CHANGE      YIELD  CHANGE
    3/4%    2-year  100 12/32  dn 0/32    0.184%  +0.4BP
    1 1/4%  3-Year  100 15/32  dn 2/32    0.343%  +1.3BP
    2 1/4%  5-year  102 11/32  dn 13/32    1.009%  +8.0BP
    2 7/8%  7-Year  103 31/32  dn 27/32    1.635%  +12.0BP
    3 5/8%  10-year  98  3/32  dn 1 12/32  2.333%  +15.2BP
    4 3/4%  30-year 110 25/32  dn 4 28/32  3.784%  +24.7BP
    2-10-Yr Yield Spread: +214.9BPS Vs. +191.9BPS

[doodle]

Regarding inflation and 30 year yields...in previous discussions many have said that moderate M2 money supply growth means inflation pressures are contained. This article might suggest that the M2 number is being distorted.

http://www.cnbc.com/id/44115892

Banks and corporations are afraid to keep their massive cash reserves in bank accounts and instead have favored short term treasury paper.

Pozsar argues that this has created a big distortion in the monetary aggregates (ironically, cash is only counted as M2 “cash”? in the Fed’s accounts if it is held in a bank.)

The article didn't really talk about the implications, but it might explain tepid M2 growth.

[Gumby]

30 year bond auction demand yesterday was apparently pretty poor. This might have been because upside market action peeled off the buyers....I don't know. My track record with 30 year bond predictions has been pretty dismal. Nevertheless, I am going to hold my 5 year ladder until we get a climb in rates back to the mid to low 4's.....even if it takes a year or two.

Well, for future reference, it's not uncommon to get a bargain at the 30-year auction. They tend to throw bidders a bone when demand isn't off the charts. If you ever do decide to purchase LTTs, it's a fun way to get in at the maximum maturity. The last few auctions gave the LTT bidders a nice little bonus if I recall.

[Plumbline]

To MandynShane:

Here is a good read on deflation: 

http://globaleconomicanalysis.blogspot. ... nalysis%29