The Treasury Bubble May be Starting to Pop

By Phil Streible and Richard Ilczyszyn ISSUE 801 | January 2009

Risk-aversion has been driving investors over the past six months, and they have been rushing into U.S. Treasuries in what the media is now dubbing the next big bubble. But there are signs that the Treasury bubble may be starting to pop, and we recommend strategies to get short.

A crisis in the financial and banking industry, a stock market meltdown, falling housing prices, commodity deflation, and a resurfacing of Middle-East tensions had investors wondering where to put their money in the past few months. Yields have been pushed down to historic lows across the yield curve, and in an unprecedented development, three-month Treasury bill yields actually turned negative in December.

However, investors will lose their fear as the stock market improves, and the safe-haven play dominating the markets over the past couple months will likely be unwound. It could result in a significant move lower in Treasury futures prices, which trade inversely to yields. We could see a correction of as much as 25 percent in Treasury prices. 

We are already seeing signs some air is being let out of the bubble, as Treasury futures prices have been dropping since late December and the media is picking up on the trend. The cover story of the January 5, 2009, issue of Barron’s was titled “Are Treasury Bonds Safe? Get out Now.” It’s author claims better values are now to be found in high-yielding municipal and junk bonds.

The 30-year Treasury bond yield fell below 2.7 percent in late December, while the 10-year Treasury note yield has seen its lowest levels in half a century, hitting 2.0352 percent on December 18. In mid-June 2008, the 10-year yield was at 4.3 percent, and the 30-year yield was at 4.8 percent. Last month, 10-year Treasury note yield even briefly fell below the dividend yield on Standard & Poor’s 500, which hasn’t happened either in 50 years. This was evidence investors are afraid the economic recession will deepen and weren’t terribly confident in the stock market.

Some analysts say Treasury yields could drop even more, but we don’t think this trend will continue much further into the new year, and it may already be ending. In January, the stock market has historically been strong, and investors are likely to shift some assets back into the market as optimism about the coming year. (According to the Stock Trader’s Almanac, January is the top-performing month for the Nasdaq.) We’ve already seen Treasuries pull back a bit in the first few sessions of the new year.

Right now, we recommend buying the June 125/120 Treasury bond put spread at $1,050 or better. That would be your defined risk on the trade (not including commission costs). These options expire on May 22, so that gives you enough time to take advantage of an abatement of investor fear, and optimism the economy will turn around next year. Watch the 50-day moving average in this market, as it tends to gravitate toward that price. When bearish momentum starts building, Treasuries could drop quickly.

With options, you don’t have to worry as much about the timing of the trade as you do with an outright futures position. You can be in the trade for several months without being stopped out if the market continues its current trend a while longer. The March 30-year bond is currently trading just above 132.
At the far short end of the yield curve, yields have hit rock-bottom in the past month. In a crazy development, the yield on the three-month Treasury bill fell to -0.01 percent on December 9, 2008.

The government had sold $30 billion of four-week bills at zero percent for the first time since it began selling the securities in 2001. We are not only headed toward a zero-rate policy, it looks like we are already in it. Investors seemed more worried about putting their money in the bank than with the government. But that won’t last forever.

The key U.S. short-term interbank lending rate known as the Federal Funds rate is now at 0.25 percent, about as low as it can get. This easy Fed policy has the potential to fuel inflation, also a risk to Treasury prices. As we head into 2009, it seems investors are losing their aversion to risk and not only putting some money back into stocks, but ready to seek alternative investments.

Feel free to call us for more specific strategies in this or other markets to suit your individual risk tolerance, and ask about a special half-off offer for new clients.

Phillip Streible is a Senior Market Strategist with Lind Plus. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com.

Richard Ilczyszyn is a Senior Market Strategist with Lind Plus. He can be reached at 800-605-0095 or via email at rilczyszyn@lind-waldock.com.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached at editor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

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