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Treasury Yields at New Lows


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http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield_historical.shtml

 

The 10 year has went from nearly 4% at the start of the year, to under 3% today, the lowest levels we've seen since the market crash back in March. The 2 year is now at an all-time low.

 

I think it's interesting that the market has once again foxed the consensous of investors expectations (i.e. the future is inflationary and treasuries are a terrible investment).

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I wonder what Prem Watsa, Brian Bradstreet, et al. have been doing over the past few days....  Dumping treasuries and buying large caps?

 

Personally, I could not resist increasing my Manulife position today.  MFC looks be valued at PE~7-8, and has enormous potential in the Asian markets....  I'm happy with this opportunity!

 

SJ

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Stubble, I am looking forward to seeing what changes Fairfax has made to their portfolios in Q2. They have been very good at being in the right asset class the past few years.

 

In Q4 and Q1 they were net sellers of stocks; the correct move should the current sell off get more aggressive.

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I find it interesting that with bond rates so low, stocks are still high relative to March. Overall, I am with you, the situation doesn't make sense. Is this implicitly stating that a crash in stocks is coming?

 

What happens when bonds eventually get dumped and rates rise? The money either gets spent, which will help earnings, or, it gets redeployed in stocks, bidding up prices? When the fed raises rates will everything just work it's way out?

 

The situation just doesn't make a whole lot of sense.

 

Implicitly, people are stating with their wallets that they trust the US government to pay them back more than they do most US corporations. Personally, I trust most corporations to pay me back their debt more than the government, absent some crazy seizing of assets or legislation. Even as much as the board seems to hate Sardar Biglari at the moment, I think that everyone would rather have a SNS bond over a US one. ;)

 

Anyone buying TBT calls?

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Implicitly, people are stating with their wallets that they trust the US government to pay them back more than they do most US corporations.

I don't think it's a given that people will dump treasuries, at least not in the short-term. Remember, United States citizens have only 2% of their household worth invested in treasuries. If we were only to return to the long-term historical average of 5%, we would see yields plunge from even these low levels. Is this a completely ridiculous outcome? I don't think so, I am just trying to illustrate that when a trade becomes entirely one way, investors expectations may not always follow.
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Given the state of the US gov't finances, I think you will see less investment in tresuries.  Why would a rationale person lend money to the US gov't when you can lend to much more creditworthy borrowers and get multiples of the interest?  The idea that the gov't is safer than some of the large corporations is based upon a fact that historically it has been conservatively finanaced and never approached a debt spiral tipping point of debt to GCP of 90%.  I think this assumption has changed but the market has not caught on (much like the subprime crisis assumptions that housing prices will always go up).  It will be interesting to see if Fairfax and others have purchased US CDS.  US gov't CDSs anyone?  I know TBT investors are down YTD so this may be similar to CDSs Fairfax purchased (first the pain then the gain).

 

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We do not live in a North American vacuum. If you are a pension fund or a central banker, which would you rather own. A Euro bond, an African nation bond, an Argentina bond, an Indonesia bond, or even a Japanese bond. Given your choices, it seems reasonable that US bonds look better comparatively and part of the reason for the drop in yields. Also, if you are in the debt-deflation camp, rates may even go lower.

 

From Hoisington Investment Management, With excessive levels of debt and contractionary monetary and fiscal policies in place, inflation will continue to moderate, thereby driving long term treasury yields lower. The path to lower rates will not be smooth as volatility will arise from heavy sales of U.S. government debt and occasional transitory improvements in economic activity. However, patient investors will be significantly rewarded.

 

Cheers

James

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We do not live in a North American vacuum. If you are a pension fund or a central banker, which would you rather own. A Euro bond, an African nation bond, an Argentina bond, an Indonesia bond, or even a Japanese bond. Given your choices, it seems reasonable that US bonds look better comparatively and part of the reason for the drop in yields. Also, if you are in the debt-deflation camp, rates may even go lower.

 

From Hoisington Investment Management, With excessive levels of debt and contractionary monetary and fiscal policies in place, inflation will continue to moderate, thereby driving long term treasury yields lower. The path to lower rates will not be smooth as volatility will arise from heavy sales of U.S. government debt and occasional transitory improvements in economic activity. However, patient investors will be significantly rewarded.

 

Cheers

James

 

Well said James.  Given the choice for safety would you rather invest in a country that is self sufficient in nearly every way:  food, resources, education, energy (incl. Canada), and has a history of always paying its debts or one of the others, and a history of tech and financial innovation.  I am a very proud Canadian but you can provide me with any other investment on Earth and I can show you something wrong with it that makes it worse than US debt. 

 

Japan Debt: close but doesn't have the demographic or resource backing

Eurodebt - close but energy and resource backing is problematic.  Demographics working against you except perhaps UK.

Canada debt - too reliant on US for prosperity.

So what left?

 

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So what left?

 

I'm not a bond investor, but if I would have to own bonds, I would try to search for things that are more attractive on a risk adjusted basis. When people favor something, there is something else that becomes unfavored.

 

 

 

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David Rosenberg has mentioned many times that government bond bears focus only on supply. David's view is demand for all bonds is outstripping supply as Boomers are beginning to rebalance portfolios shifting holdings from stocks to bonds. I also see this on a personal level as many of the Boomers I know have been told by their advisers to increase bonds holdings and they are doing so (with gov't bonds getting their fair share). Should equities sell off again (reasonable chance this will happen) the appeal of bonds will only increase (and yields will continue lower to levels we never thought possible). This is also the trade no one is expecting....

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From Hoisington Investment Management, With excessive levels of debt and contractionary monetary and fiscal policies in place, inflation will continue to moderate, thereby driving long term treasury yields lower. The path to lower rates will not be smooth as volatility will arise from heavy sales of U.S. government debt and occasional transitory improvements in economic activity. However, patient investors will be significantly rewarded.

 

Perhaps extremely patient investors will be significantly rewarded.

 

Didn't he continue to hold his long bonds when the 30 yr hit 2.5%?  Wasn't low enough yield to sell?  In every way that feels like reaching for yield to me, but he clearly doesn't think so.  For a significant reward, presumably he means a price much better than that -- what would that look like to him... 2%?  1.5%?

 

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I also see this on a personal level as many of the Boomers I know have been told by their advisers to increase bonds holdings and they are doing so (with gov't bonds getting their fair share).

I wouldn't think it's just Boomers.

 

http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm

 

With an increasing rate of savings, much of this is likely to find its way into Treasuries.

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Guest HarryLong

I think it is very instructive to look at the arguments of proponents of shorting sovereign debt, such as Kyle Bass at Hayman Capital.

 

http://www.marketfolly.com/2010/01/hayman-capitals-kyle-bass-outlines-how.html

 

http://www.marketfolly.com/2009/05/hayman-capitals-kyle-bass-predicts.html

 

The problem with shorting sovereign debt, is that even if it is fundamentally over-valued, a short position in sovereign debt is implicitly short volatility, due to flights to safety into government debt in time of panic, fear, etc, as we have seen with the yield on the 10 year this week and also with the yield on JGBs.

 

In my view, there are more elegant ways to express a negative macro view on government solvency and sovereign debt which are not implicitly short volatility.

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Naill Ferguson's suggestion is to buy blue-chip corporate bonds as a substitute for gov'ts.  He was looking for some Tata bonds to buy at the DCF conference.  I also think that safe high yielding utilities like Excelon will provide yield plus inflation protection via Nuclear power production.  In addition, Seaspan and other income based trusts can provide interesting substitutes.  I have a tendency to disagree with Hoisington because his thesis is based upon the gov't not defaulting (which historically there was a stigma attached to it) which I think will be more painful than a partial default in the developed world.  When this occurs these high-quality alternatives will be in great demand.

 

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I tend to agree with the basic thesis that its hard for a company to have a better credit rating then the country it operates in. I think deterioration in US credit ratings / the US economy will affect companies which heavily depend on the US Markets. I also dont think we will see decoupling.

 

I also agree with Stiglitz and Krugman. A country cannot default if debt is owed in its own currency.

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The only problem with Krugman's argument is that it did happen in Argentina and many other countries.  I think the key point which is valid is that the credit rating of a country and firms in the country can and do diverge and to think of them as distinct does have historical precedent versus the theoretical Krugman argument which may in most but not all cases be true.

 

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The only problem with Krugman's argument is that it did happen in Argentina and many other countries.  I think the key point which is valid is that the credit rating of a country and firms in the country can and do diverge and to think of them as distinct does have historical precedent versus the theoretical Krugman argument which may in most but not all cases be true.

 

Packer

 

Do you mean the credit ratings decoupled?, or Argentina defaulted on debt in its currency?

 

With regard to the first one, I the ratings may decouple and a few businesses may do well but I think we would all be screwed (holding the equities of US specific firms, and more importantly living in the US) if they didnt sort this out. Even GE was having problems getting cash and many would have thought they were fairly safe.

 

Severe Inflation or deflation seems to ravage most businesses in one way or another.

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I also agree with Stiglitz and Krugman. A country cannot default if debt is owed in its own currency.

 

Myth, why do you say that? What's to stop the Fed (or any other government) from going "We can't afford the current debt load, we are restructuring and everyone gets $0.50 on the $1"? Im not saying it would happen, just that it could, regardless of the currency it is in. The economic fallout of a US default would be huge and I'm sure behind the scences manouvering will ensure it never happens. More likely the government inflates its way out of a problem i.e. you get paid back in dollars worth much less than they used to be.

 

cheers

Zorro

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Easier.

 

I know Obama, and who ever else is elected doesnt want to be the first President of the US to default on the nations debt.

 

Much easier to just print a few Benjamins and pretend they are still worth something.

 

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"can't afford the current debt load, we are restructuring and everyone gets $0.50 on the $1"

 

Because the buyers of that debt made the purchase under the assumption of price stability, mildly inflationary with prices creeping up slowly over time. Things like default turn those expectations on their head and you definitely get Japan and deflation in America.

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I think a key premise about the argument that we can print our way out of it is that others will be willing to hold US gov't debt.  Why do people hold our debt?  Because they think our gov't can tax and get the money (not print our way out of it).  Taxing in theory is doable but in practice I think is impossible.  I think holding US gov't debt is different than holding US dollars which is backed by the US economy.  I think there may be a decoupling of the US dollar and gov't debt.  It is interesting that even though almost 40% of our debt is due to roll between now and 2012, that the duration of US debt is shrinking. 

 

What that tells me is no one will lend to the US gov't long-term and why would they when the crew in Washington is oblivious to racking up debt (it reminds me of real estate in the subprime credit crisis).  The only way out I see is a veto proof majority in the House and Senate before the big roll-over (a highly unlikely event) which may provide the markets some solace that the spending will be under control.  Even if we can roll over the debt I think it will be for a shorter duration which will just kick the can down the road.  Even if the Repubs get majorities in both chambers, Obama and crew show no signs of deviating from Keynesian orthodoxy so I think we will not seen restraint until at least 2013 and by then it may be too late to prevent and a partial default (extending maturities and lower debt interest rates).  The US Gov't bond rally reminds of the housing bubble being based upon an assumption that every thinks is true (the US gov't cannot default) but in fact may not be true and has commonly been done throughout history to get out from under a debt pile and may be less painful than inflation.  It would be interesting to see if Farifax is picking up US gov't CDSs which are only trading @ 40bp.

 

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Ferguson talks about maturities, and its an interesting point. They are getting shorter and shorter.

The only issue I have is the government can still simple print up the money and pay off the debt, whether its due next year or in 10 years. Dont get me wrong it will cause fiscal hell but it can be done.

 

My problem with people who want to cut spending is they arent serious enough. They want to cut spending in a why that causes a double dip (removing unemployment extensions for example), but ultimately does nothing about long term debt. It seems a bit pointless. The same people vote to keep biggest spending program we have going Afghanistan and Iraq wars, but then want to cut services which cost pennies in comparison.

 

I think you need to go extreme one way or the other. Take an axe to just about any spending that isnt required to cut the deficit and debt, or use counter cyclical policies (which means savings / paying down debt when times are good). I think trying theories from all economic schools (they all contradict each other) will do nothing but exasperate this problem.

 

Trying theories from a school that says markets are efficient and self correct, appear to me to be a recipe for disasters.

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True enough about unemployment but we need to find money from somewhere else to pay for it.  Just adding more spending at this point is just pushing us closer to the point of no return.  I think Paul Ryan has a serious plan but no one considers it because in part the crew in the WH thinks we can still spend our way out of this.  I think we can have a debate about this but the WH is preventing (like on health care) the real debate and compromise from happening with their my way or the highway approach to problem solving (and you thought Bush was bad - Bush only did it for Iraq these guys are doing it in everything).

 

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