A Case For Buying Treasuries

The majority of investors seem to hate them and the rest are shorting them. While at some point shorting bonds will be a huge trade we think that the timing is still a ways off for the end of the 31-Year bond bull. So what do bonds have going for them? Well the most obvious and yet what seems to be the most overlooked is the simple trend. Looking at the chart below you should ask yourself how many times have investors been convinced that rates were too low? (click on chart below to enlarge)

30-Year Treasury Yield

Aside from the trend we have the current situation with GDP growth of only 1.7% which is very slow for a so-called recovery, especially one that is five years along. In addition we have very slow growth globally as Europe continues to blow up and we keep seeing estimates for China drop every month or two. We have very slow global growth and this is showing in very low inflation data. Yes, the central banks led by Helicopter Ben are juicing the system, hell I hear Ben is dressing up as Buzz Lightyear for Halloween so he can say “QE to infinity and beyond” but the fact is that despite their best efforts inflation remains muted.

In a world of extremely slow growth and chronically low inflation we would expect Treasuries to do well and lo and behold they have. Since QE1 was announced November 25th 2008 we have seen 30-Yr yields drop from 3.632% to 2.988% and the 10-Yr dropped from 3.092% all the way to 1.811%. If this does not make it obvious that QE alone does not cause the bond market to crash then nothing will. No, until we see stronger growth and a large pick up with inflation we expect fundamental picture to remain decent to strong for Treasuries.

Now of course we are going to get some people saying “but bonds are up too much” our natural response would be something like WTF? but our more reasoned response would be compared to what? Bonds have been up “too much” for the last 20 years. Who would have ever thought that 5% 30-Yr interest rates would sound high? Rates are low but they are a long ways from 0% which would indicate that they have room to go lower. That said what does the technical picture look for bonds? In the chart below we have our intermediate term 30-Yr Reversion to the Mean (RTM) chart. While the RTM chart isn’t saying load the boat it is also not saying run for the hills as it is instead giving us an almost perfectly neutral reading which indicates that bonds have plenty of room to go up or down before reaching anything near an oversold/overbought point. (click on chart to enlarge)

30-Yr Treasury RTM

Finally, at least for now, is the sentiment picture. We all know that volatility is one of the most mean reverting series in all of finance. In the chart below we have the Treasury MOVE index vs the 30-Yr yield and then we have overlaid the 30-Yr yield with an inverse scale. We inverted it so it is a better visual as to what happens to bond prices when the MOVE index is so low. As you can see when Treasury volatility is really low it is usually a time to be buying bonds and when it is high is when you should be selling. Well right now we are hovering close to the lows of the past five years indicating that bonds could take off at any time. (click on chart to enlarge)

So is going long bonds the new trade of the century? Nope not by a long shot. Still that doesn’t meant that there isn’t a case to be made for being long. The economic fundamentals are in place, unless you think we are the cusp of a huge growth spree. The technical picture is saying that while its not a perfect buy there is plenty of room to run. Finally sentiment/volatility are saying that the time in at hand for a renewed move higher in Treasury bonds. Obviously we could be wrong but the risk reward is there.

Happy Trading,

Disclaimer-In our model portfolio we are long TLT, AGG, and FLAT.

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The MOVE Index And Outlying Events

In the investment world it should be no surprise to anyone anymore that outlying events actually happen with a decent amount of regularity. Looking at the past 12 years we have had the Asian Contagion, Russian Default, LTCM, .Com crash, housing crash, and the subsequent crash of everything else. Most of these are one in a gazillion year type events and yet they all happened inside of 12 years. Statistics while useful, are not able to perfectly model the real world.

So mixing stats with history let us look at the MOVE Index. The MOVE Index, essentially the bond markets VIX, typically trades between 128 and 79. Anything outside of those two lines is at least one standard deviation from the mean. As you can see in the chart below we are currently more than one standard deviation below the mean and look to be headed lower. (Click on chart to enlarge)

MOVE Index


Of course the interesting thing about the MOVE Index is not what level it is at but what tends to happen when it reaches certain levels.  Essentially whenever the MOVE Index drops below one standard deviation something blows up. Apparently bond market investor complacency is a better gauge of “too complacent” than other volatility gauges.

Drops below the lower one standard deviation have preceded the following events

-First Gulf War

-Asian Contagion

-LTCM bailout/Russian Default

-.Com tech crash

-Housing/Credit crisis

While it is not a crystal ball, see the extended period below one standard deviation preceding the credit crisis, the MOVE index is still a good risk gauge with a solid track record of saying investors are too risk averse or that we are too complacent and therefore not really aware of the risks on the horizon.  Consider this the yellow light, its not saying stop but its not saying go either.

Happy Trading,

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Global Interest Rate Outlook

It has been a while since the last time we posted our global GDP weighted yield curve.  While it has been months it might as well have been a day as nothing has really changed.  After being inverted for all of 2007 and most of 2008 the yield curve flipped and became extremely positive as central banks worldwide lowered short term rates.  You can see this very clearly in the chart below of the G-10 nations short and long term rates. In spite of Australia raising theirs, short term interest rates remain extremely low everywhere else.

G-10 Short and Long Term Interest Rates


Another way to look at interest rates and in fact the title of this post is by using the global GDP weighted yield curve.  In the chart below you can see the global yield curve.  While it has fluctuated it has essentially gone nowhere for the last eight months.

Global GDP Weighted Yield Curve


So whats The Macro Traders outlook?  We think that things will remain more or less the same for most if not all of 2010.  On the deflationary side banks have not started to lend, real estate is not going up anytime soon, debt deleveraging is in overdrive, unemployment is as bad as ever, etc.  On the inflation side commodities are up, stocks are up, and bonds are up.  At best we would call this a standstill.  So while we could envision long term rates going higher on credit risk, yes we think that sovereign debt is full of credit risk, we think that short term rates will remain low for most if not all of 2010.

Happy Trading,

Disclaimer-The Macro Trader is long TLT

Favorable Risk to Reward in Treasuries

While many investors are calling for a large drop in long term Treasuries we are currently seeing a good risk reward trade to the long side in the long bond. In the chart below you can see our reversion to the mean chart on the 30-year Treasury yield. When it is stretched to the downside things are bearish and when it is stretched to the upside it is bullish. Right now it is stretched almost 1.5 standard deviations away from its historical mean which usually leads to a move lower in yields and a move higher in bond prices. (Click on chart twice to enlarge)

30-Year Yield Reversion to the Mean Chart


As you can see in the chart below of the 30-Year Treasury yield we are at the top of a long term downtrend in yield. Each time since the 1987 that yields have hit this line they have gone lower. Eventually this will stop and yields will breakout to the upside but if history is any guide and the trend continues than at least for now yields are once again headed lower. (Click on chart twice to enlarge)

30-Year Treasury Yield


Finally lets look at the LT 20+ year Treasury bond ETF. As you can see below it has found support over the last seven months in the highlighted $86-89 range. On the upside we have resistance around $98. The risk to reward is quite favorable right now as we can risk $1-2 with an upside around $9. (Click on chart twice to enlarge)

TLT-20+ Year Treasury Bond ETF


So while this may be the time that Treasuries tank and yields go screaming higher we doubt it and are modestly positioned to the long side. Eventually we will be shorting Treasuries but not until yields break out and end the trend that has been in place for over 20 years.

Happy Trading,

Disclaimer-The Macro Trader is currently long TLT

G-10 Interest Rate Trends

While a lot has been made of the RBA raising Australia’s short term rates over the last week the fact is that most of the world is not doing quite as well.  Whereas Australia actually has some inflation the United States, Japan, and Europe are still not growing and rates are likely to stay around their current levels for at least a few more quarters.

Australia on the other hand was able to avoid a large part of the current global recession by supplying Asia, namely China, with commodities.  As you can see  in the chart below the short term rates have climbed but in spite of this the long term rates are still basically unchanged. (click on chart to enlarge)

Australia Interest Rates


Looking at the G-10 as a group we can see that rates are low and aside from Australia and New Zealand rates are essentially unchanged for the past six months as central banks continue to fight deflation and disinflation.  The trend is flat and likely to stay that way. (click on chart to enlarge)

G-10 Short Term Interest Rates


With the current rally and all the talk of inflation you would expect that long term rates would be climbing but instead they are flat to trending lower in every single G-10 country.  Treasury bonds night be in the bubble of a lifetime but we are not seeing that yet with lower rates and extremely slow global growth, especially in the developed world. (click on chart to enlarge)

G-10 10-Year Interest Rates


If you want to see a cleaner chart with the average G-10 long and short term rate you can look at the chart below where we have taken a simple average of G-10 long and short term interest rates.  As you can see everything has remained the same for a few months now. (click on chart to enlarge)

G-10 Interest Rates


Finally lets look at the whole investable world.  As you can see in the chart below the Global GDP weighted yield curve has been flat since May 2009 with very little change.  If inflation is hitting the world right now then it would appear as though bond investors are clueless.  In our experience bond investors are rarely clueless and we are inclined to bet with them.  Right now we are looking at potentially re-entering our long bond trade as investors come to the realization that we, along with investors such as PIMPCO (maybe its PIMCO but the way that Bill Gross ran the Fed last winter we can’t help ourselves) , see slow to negative global growth over the next year and probably for the next few years as the worlds financial system rebuilds, assuming we get that far. (click on chart to enlarge)

Global GDP Weighted Yield Curve


Happy Trading,

Disclaimer-We are long some GLD, DBV, and HYG

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Title: G-10 Interest Rate Trends