July 22, 2014

Still VERY Bullish Treasury Bonds

By now, you’ve heard it a million times from a million talking yakheads: “Interest Rates HAVE to go up”, like it’s some sort of economic law…but the truth is, LONG TERM INTEREST RATES COULD BE STAYING AT CURRENT LEVELS…AND LOWER…FOR YEARS TO COME…WHICH WOULD MEAN HIGHER TREASURY BOND PRICES…I’ll get around to some reasons why a little further down the page, but for now, just take a look at the following chart that presents one lengthy example of why I say rates could be staying “low” for years to come…In short, it has happened before and it can now be happening again.

To start with, just because this took place many decades ago does not mean it can’t happen again today. There is no law that says rates have to be higher than they are now, and as I have written before, I see only three real reasons why long term US Treasury yields (rates) could go up noticeably from here:

ONE - If high inflation (or that ever touted, but never appearing, real boogeyman, hyperinflation) rears its head…Which AIN’T happening…

Think about this…The USA and world economies have basically been in an enormous expansion for the past 30 years. Our stock market has gone up 2100%. Interest rates have dropped from 15-20% in the late 1970’s down to 1-3% in recent years. The Fed has been through innumerable versions of “easing”, the most recent being QE’s 1, 2, and 3, and for all of those 3 decades, with EVERY instance of those eases, I have heard the ever-wrong battle cry, “They are pumping too much money into the system! Hyperinflation is coming! Sell Bonds! Rates are going up!”. But the bottom line is this: IN SPITE OF ALL THOSE “PRO’S” CALLING FOR HIGH INFLATION TO APPEAR FOR OVER 30 YEARS NOW, IT HAS YET TO ARRIVE…AND IF THE WORLDWIDE EXPANSION/BOOM WE’VE LONG BEEN IN HASN’T RESULTED IN INFLATION, WHY SHOULD WE SEE IT NOW? Really, when you get down to it, since 1990 when both the ex-Soviet Union and China began climbing on board the capitalist wagon, bringing several billion consumers (and their demand) into the marketplace, if we were going to ever see prices “getting out of hand”, I really think we should have seen it by now. And we haven’t…and in my opinion, WON’T.

TWO - if the Fed were to push short term rates sharply higher…which also is not going to happen ANY time soon.

Right now, short term rates are basically at ¼ % to ½ % all the way out to next summer, and the Fed has pretty much been saying, “Will raise them, but not yet”. Assuredly, SOME day, the Fed will begin to push short term rates higher, which, depending on how much higher they push, will eventually begin to impact long term rates…BUT…contrary to what the media will tell you, rising short term rates does NOT automatically mean long term rates immediately go up as well. In FACT, when the Fed does raise short term rates, it can have exactly the opposite effect on Long Term Rates, that being, long term interest rates can actually go down…meaning Treasury Bond prices go UP.

Here’s a little more history…specifically what happened the LAST time the Fed switched from easing to tightening…

Fed Funds (the rate at which banks can borrow from the Fed) were down to 1% back in mid 2004 following the dot com and 9/11 crashes…The Fed then decided the time had arrived to tighten up and they began to do so in June of that year…Here’s how it worked in Fed Funds, and more importantly, in the Treasury Bond market.

So they took short rates a full 2 % higher in about a year…

If it’s hard to view these charts together screen, or if you don’t see the point I am making, here it is: THE FED RAISED SHORT TERM RATES FROM 1% UP TO 3%. TREASURY BONDS LITERALLY STARTED GOING UP (AND LONG TERM RATES GOING DOWN) IMMEDIATELY WHEN THE FED BEGAN THEIR TIGHTENING CAMPAIGN. EVENTUALLY BONDS DID SELL OFF, BUT NOT BEFORE THEY HAD GONE UP FULLY 15 POINTS (AGAIN, WHILE THE FED WAS RAISING RATES).

Why did this happen? Why do I think it will happen again?

In a nutshell, when the Fed begins to raise rates, the perception of their maintaining a “vigilance against inflation” is immediately reinforced…and as the number one enemy of the Bond market is inflation, it is quite understandable that Bonds often will go UP, not down (as 98% of Wall Street would have you believe)…And I think it will be no different this time around…And in the same vein, consider this: Fed Tapering, which began in January and basically meant the Fed was going to drain Bond buying out of the system, representing the first step in the tightening process, according to the yakyak internet faces, was SUPPOSED to result in higher long term rates and lower Treasury Bond prices…but exactly the opposite has happened…I believe, for exactly the reasons I have outlined here.

THREE - The third and final reason for Treasury prices to fall is almost not worth considering, but here it is: If, for some reason, the world decided that US Treasury Bonds were no longer absolutely the SAFEST PIECE OF PAPER ON THIS PLANET, if nobody wanted our debt, then (and this is really an absurd “then”) our bond prices would fall and our long term rates would then go up. However, US Treasuries ARE regarded as the safest paper in the world. This is NOT going to change and even suggesting this as a possibility (even though it was a popular conception a few years back) is, I believe, in the realm of the absurd.

As a final note,  I will reiterate that there are BILLIONS of Dollars, every day all over the planet, that HAVE to be invested, TODAY, in some sort of fixed income instrument (like Bonds). Whether it’s coming from banks, insurance companies, pension funds, sovereign nations, bond funds or whatever, the managers of those entities HAVE to buy the market. In general, they can’t park it in cash, earning zero percent, while they “wait for rates to go higher”, or until they “like the market”. They have to scan the globe, and within certain guidelines, spend the money as best they can with regard to safety, duration and yield…and RIGHT NOW, in my opinion, U.S. Long Term Treasuries are probably the BEST buy in the international fixed income marketplace. The following table is almost self-explanatory as to why.

Just about every developed nation issues a 10 Year Note (or Bond). When an international buyer is looking at the market, he must consider not only the yield (interest paid) but also the stability of the issuing nation, the stability of its currency and the prospect of potential interest rate increases (making the bond worth less), all of which means there is some judgment involved as to what country’s paper in which you invest.

To add a little perspective to how they make those decisions, what follows is a somewhat random list of countries who do issue 10 Year Notes, together with the actual interest rate (yield) they are paying today. I have placed the USA rate, at 2.46%, at the top of the table, and then as you go further down the list, you will see the yields get higher and higher. This is reflective of the global perception that there is more risk involved in buying those instruments…that, for example, they may lose value, either through actual face value deterioration OR currency depreciation or even default…and as they involve more risk, to get people to buy them, the issuing country has to offer a better return.

So, imagine that you have to invest funds with a 10 year time frame…somewhere, TODAY…in one (or more) of these countries. How do you decide? Switzerland sounds safe…but at .51% for 10 years? That’s like a zero return. Germany is safe as well…but at 1.16%? Not much better. Spain is paying 2.57%, about the same as the USA, but they have 25% unemployment which just doesn’t sound like a healthy economic environment…so why even consider it when you can get the same yield, and more security in the United States?…So how about Mexico at 3.37? Really? Get an extra ¾ % and bear the risk of a peso devaluation or whatever malaise the drug wars can inflict on their economy? Yes, they are our neighbor but are in many ways and economic and social mess. Or how about China at 4.30%...except for the fact NOBODY in the West really knows anything about what the real economic numbers are there? They have ENTIRE newly built cities that are ghost towns. So who knows? And Russia? Paying a whopping 9.03%? Sink your money for 10 years in one of the most corrupt countries in the world? And all this latest crap with Putin? Don’t think so…

My point is, there are various considerations to be made each day with all the funds that WILL be buying fixed income SOMEWHERE on planet earth…and no, the USA is not the perfect choice 100% of the time, but it IS always going to in the running as a top pick. ALWAYS. Which is exactly why there is a line of buyers EVERY time the US government holds a Treasury auction, and which is exactly why I CONTINUE TO BELIEVE ONGOING WORLDWIDE DEMAND FOR QUALITY FIXED INCOME IS ONE OF MANY FACTORS THAT WILL CONTINUE TO DRIVE OUR TREASURY PRICES HIGHER.

Think about it. You’ve heard them as a tandem for your entire life. Stocks and Bonds. They really are the only places to put any savings, or extra cash, or investment capital, and there really ARE billions of dollars every day that HAVE to buy Bonds, somewhere. Inflation is NOT about to bite us. The United States economy is NOT about to fall apart. And the Fed is NOT going to present us with 3% short term interest rates in the next week, or month, or two…Maybe a few years down the road but not NOW…But NOW is, I believe, absolutely the time to be buying the bond market.

I CONTINUE TO RECOMMEND BUYING TREASURY BONDS HERE. I CONTINUE TO SEE THEM AS BEING ON THE CUSP OF A SHARP, RELATIVELY STRAIGHT UP MOVE HIGHER. I CONTINUE TO BELIEVE THEY CAN EASILY BE TRADING 8-10 POINTS ABOVE CURRENT LEVELS BEFORE WE OFFICIALLY GET TO FALL.

Here are the usual charts with options I like…

I really think this market is just one good day away from shifting totally into some degree of lift off mode…Maybe I’m wrong…but I think I have seen this chart 100’s of times…

And here is the smart way…using the 2 & 1.

And oh yeah…Small Speculators, the perpetual fodder in the markets, are STILL short Ten Year Notes at RECORD LEVELS. I think they are about to get it totally handed to them.

I’ll cover Soybeans (which I missed as badly as anything I have predicted in YEARS), Cocoa and Cattle (which have both only gone sideways recently) in my next letter.

If you have ever traded Bonds with me before, you MUST have seen this set up before...Give me a call. I think the ride is just starting, and in fact, I think the REAL move is immediately in front of us…that the sideways to higher maddening of the past three months IS about to change…to non-stop on the upside.

Maybe I’m wrong, which would mean losing money for sure…but I am all over this.

Thanks,

Bill

866-578-100

770-425-7241

The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Treasury Bonds