Over the last few months U.S. Treasury bonds have defied the naysayers and pushed to levels not seen since last October. This came as a surprise to many, especially since the government has already hit the debt ceiling and three major credit rating agencies have threatened to downgrade the U.S. credit rating if Washington fails to act as technical default looms in August.
The rise was driven by an increase in demand for safe haven assets as the economy hit another soft patch. Other factors included the European debt crisis, stabilization in the U.S. dollar, and a whiff of disinflation as Wall Street marked down growth expectations.
But now, the naysayers look ready for their time in the sun as risk appetites rebound and the economy looks ready to reaccelerate and surprise newly pessimistic investors. And that means it's time to bet against the U.S. government by betting against its bonds. Here's why.
For sure, there are plenty of reasons to think T-bonds will head lower from here. My last two blog posts have outlined how the Fed's stealth stimulus will keep real rates low and give the economy a small push in the short-run. Although the stealth stimulus should support U.S. equity prices, the same cannot be said for its effects on Treasuries.
The end of the $600 billion QE2 money printing operation, bubbling inflation pressures, and the government's struggles with the debt ceiling are the three main reasons why Treasuries are set for a decline in the coming weeks. Currency effects from a strengthening euro, due to interest rate hikes from the European Central Bank, will also weigh on T-bonds.
The Fed will be ending the majority its purchases of Treasuries this month as QE2 ends. As a huge buyer of treasuries, this will result in a dip in demand, ultimately reducing prices in the open market. Without the Fed's support, it will take time for banks and foreign investors to fill the void in demand. With a "QE3" off the table, look for prices to drop until the market is able to correct for this.
Societe Generale economist Aneta Markowska worries that Treasury auctions will become more volatile as the Fed steps back -- causing investors to demand higher yields in exchange for the added risk. The chart above shows the task that lies ahead for the market as it makes up for the lost buying power of QE2.
While investors have been able to prepare for the end of QE2, the problem with inflation has only recently crept back into the picture. With the Fed's stealth stimulus keeping real rates in negative territory, inflationary pressures will only build as growth revs up again. This is bad news for bondholders, as inflation erodes away the value of future interest and principle payments.
Finally, with Democrats and Republicans still far apart on the actions needed to quell the debt problem it's likely that the Treasury will come very close to its August 2 deadline. The two parties ran the clock out back in April when it came to the 2011 budget, which resulted in a short shutdown of the government. Similar brinkmanship is likely to seen again.
Tom McClellan of the McClellan Market Report is beginning to see a shift in sentiment among investors as they begin to discount all of these factors. Right now, commercial traders (the "smart money") are moving into their most negative stance on T-bonds since the highs seen last fall. At the same time, retail investors have flooded into T-bond ETFs like the iShares 7-10 Year T-Bond ETF (IEF) at a pace normally seen near meaningful tops for Treasury prices.
Technically, a breakdown seems to be in motion now after a poor 30-year bond auction on Thursday. The iShares 20+ Year Treasury Bond ETF (TLT) has formed a "bearish engulfing" pattern and looks ready to head lower.
I've recommended my newsletter subscribers take advantage with the leveraged Proshares UltraShort 20+ Year Treasury (TBT), which returns twice the inverse daily return of long-term Treasury bonds and was selected with the help of technical screens developed with Fidelity's Wealth Lab Pro back testing toolset which you can find here. (Editor's note: Fidelity sponsors the Investor Pro section on MSN Money.)
Disclosure: Anthony has recommended TBT to his newsletter subscribers.
Check out his new investment advisory service, The Edge. A two-week free trial has been extended to MSN Money readers. Click here to sign up.
The author can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. Feel free to comment below.
Anthony,
You're right on with this one! Actually this is a WOW! moment. You're actually rather stoical and sanguine about this issue. The fact is this: The treasury bond is about to lose its best customer. Last month we learned that the bond market lost its second best customer - PIMCO. Now folks, I want you to ponder the idea of a business, any business, losing its best two customers!
Chad in CO
With any luck, the government will default on its obligations, the pblic will wake up from its coma and we can start over again. The problem is that the public today is far less intelligent than it was in 1791, so I am not confident in what a new constittional convention would produce.
Your charts and graphs are very very pretty. But they do not speak for the people on the street with common sense. I can put on a chart to say whatever I want it to say and then rationalize it based on my agenda or gut-feel. Bonds will continue to be a safe haven no matter how dumb our government is. Why? At this point what are the alternatives? You either buy bonds or believe the entire system is ready to come crashing down. If it does, does it really matter? At least you know who to go after to get your money back.
Steve Phillips, Cincy, Ohio
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