Why You Should Consider Owning Treasuries
It seems that investors are convinced that interest rates are rising, no matter what their economic outlook is. Those who believe that there is an economic recovery argue that there will be a “great rotation” from bonds into stocks, and this will cause bond prices to fall. Those who believe that there is no economic recovery argue that the United States will have trouble paying its bills and it will be forced to pay higher interest rates to borrow money. There are also those who believe that inflation is coming and that interest rates have to rise in order to reflect the falling value of the dollar. All of these positions, coupled with the simple historical observation that interest rates have never been as low as they are now except in the past few years, point to a mass consensus that investors should sell Treasuries.
This is an excellent reason to consider going long. When everybody is of one belief and on one side of a trade, the risk/reward favors the other side of this trade. In the case of Treasuries there doesn’t seem to be anybody left to develop a negative sentiment and go from owning them to selling them, or even shorting them. Furthermore, while the Treasury bears may have a strong fundamental case, there are several short-term factors that indicate a potential upswing as we look at supply and demand factors.
Regarding demand, the most obvious source is the Fed, whose ongoing quantitative easing program leads it to purchase $40 billion worth of long-dated Treasuries monthly. The Fed also replaces Treasuries when they mature, and it uses interest payments it receives to buy more. In all, from November 2012 through November 2013, the Fed purchased more than $500 billion worth of Treasuries, and it is still the world’s largest buyer. Furthermore, there is still significant Asian demand, most notably from China and Japan. The Chinese added over $130 billion worth of Treasuries last year, and the Japanese added $68 billion.
Regarding supply the government’s deficit has been shrinking: its current deficit has shrunk from well over $1 trillion to under $700 billion reflecting higher taxes, lower defense spending, lower expenditures on the poor, and declining interest payments due to the fact that the government is issuing more short-term debt relative to long term debt.
Given these short-term catalysts and extreme pessimism regarding the bond market, I think investors should consider buying long-dated Treasuries. The simplest way to do so is to purchase shares in the iShares Barclays 20+ Year Treasury Bond ETF (NYSE:TLT). Aggressive traders may want to leverage this trade by purchasing shares in the Dirextion Daily 20+ Year Treasury Bull 3X Shares ETF (NYSE:TMF).
Before buying these securities, however, bear in mind that this is for a trade only. The Treasury bear case is rock-solid. Interest rates are historically way too low. Government debt is soaring given the rise of unfunded liabilities. These are not counted in the deficit or the total debt load. Thus, for example, when you pay the government for Social Security, the Treasury counts that as tax-based income, but it does not count the liability side of the equation (i.e. the part where it owes you money some time in the future). While these aren’t immediate problems they imply that any bullish bet on Treasuries must be a short term bet.