Monday, August 16, 2010


Below is a picture of TLT, the exchange traded fund that measures the long dated treasuries in the market (20 year plus).  As I've posted before, TLT's breakouts in August of 2008 were a lead indicator for the stress in the equity markets and economy as investors fled to the "safety" of US government treasuries.

As we see in the chart below, I warned a month or so ago that the push up in prices (yields going down) was a warning of bad things to come.  Well, once I posted that we had a nice recovery in July and the price on  TLT dipped back below the 100.15 level which I highlighted as the warning line.

Last week, the Fed announced that they would begin re-buying treasuries when some of the mortgage debt they owned rolled off.  In essence, they wouldn't allow their asset holdings to go away, they would simply find a new home for any money that was repaid.  (I think of it this way - that the Fed is not going to give our money back, we gave it to them (taxpayer guarantee of printed money) and instead of returning it once the stated use of the dollars is complete, they are going to recycle it into purchasing treasuries.

Well, because the Fed told the world they'd buy treasuries and even highlighted which ones they'd buy, the market, (investment houses and brokers), has done what any group of smart investors would do.  They have rushed in and purchased these securities ahead of our government!  Yeah!  Isn't it neat to know that our government is so generous and willing to buy over-priced treasuries from these savvy traders?

So, does the move in TLT signal that the market is melting down, or does it signal that the FED is just stupid (or manipulative) and created a rush into that market?  The answer is probably mostly the second and a little of the first.  Here's what I mean.  By telegraphing its intentions to purchase new securities with the roll off and then describing which ones it might buy, the Fed has really begun to achieve its goals.  (They are not stupid, they are being manipulative). 
First, the headlong rush into treasuries from other participants has further lowered interest rates to all time lows and this allows the government to fund our crushing debt at a much lower cost.  The by-product of announcing this is that there are some hedge funds and investors that are simply gun slingers that are looking to make some quick bucks front-running the FED.  The recent action in TLT especially today is probably mostly attributed to these fine fellows.

But, there are some folks that simply are so afraid of a collapse in markets that they are a new class of buyers of treasuries that have never done so.  Think people in 401Ks and retirees.  These people have lost 40% or 50% of their portfolios since March of 2000 and have endured this terrible market.  They are vowing not to get crushed again.  (They might get crushed again if interest rates rise).  The surge in TLT starting in June can be largely attributed to a large amount of folks retreating from the markets entirely, shunning equities and desiring the safety (hopefully) of fixed income.  This is why corporate bonds as well as treasuries are at extreme lows in yields.

So, whats next?  Well, as we've said many times, the Fed wants low rates to get the economy going (even though it has not worked).  They are so fearful of deflation that they are doing anything and everything to try to stimulate the economy.  Is the run in treasuries over?  No yet in my opinion.  As I've said, we will see 3.0% 30 year mortgages in the next year or so.  Rates for treasuries will need to go even lower than the current historic lows to get us that gift (if you can qualify for a loan that is).

In the longer term, will buyers of treasuries get hurt?  Heck yes! 
Will the move in treasuries lead to a move down in the market?  Possibly.  I'm not 100% convinced.  The argument to support the decline would be any move down that gets going could be met with an absence of buyers as they'll have committed resources to easier leveraged trades in treasuries. In addition, if you think about it, a strong move down would actually make these buyers of treasuries even more money as a drop in markets have have others coming into treasuries looking for a safe haven. Wouldn't it make sense to create a market sell off if you had the capability to move the markets?

Why am I not 100% convinced?  Last month, I suggested that the Fed would do some type of stimulus and therefore if effective they would attempt to juice the market via use of extra dollars sloshing around to purchase equities and other assets, or effectively the devaluation of the dollar.  This is why I said that purchases should be made overseas and in commodities like gold and not in US markets.  I'm still in the camp for the month of August that this should be my approach.

No matter what, the take away here is just another demonstration of how inefficient government is.  When the Fed purchases these bonds, they will be buying at higher prices than 1 week ago due to their prior-signaling of their intended course of action.  Of course this is purposeful and their attempts are made to manipulate the market and keep rates artificially low anyway, so what's wrong with overpaying for $200 Billion in bonds between friends anyway?