Wednesday, June 30, 2010
The Treasury Bubble Bulges
A prominent characteristic of free-market economic systems is the periodic expansion and collapse of so-called bubbles. These bubbles can form in any environment where the free exchange of currency and goods exists. They are characterized by an extraordinary rise and elevation in the price of a certain good or sector relative to its baseline, and a subsequent collapse of this price. An historical example of a speculative bubble is the famous Dutch tulip mania of the 1600s, although a bubble of some sort can almost always be found in some capital market at any time. Recent financial bubbles include the technology bubble of the late 1990s, the real estate bubble of the mid-2000s, and the oil price bubble which burst in July 2008. Economic bubbles are fundamentally driven by human psychology. This is an interesting topic which is beyond the scope of the current post.
The most prominent bubble in financial markets today is the US Treasury Bond. Treasury bond prices in the last few years have seen extraordinary elevations in prices as governments, institutions, and individuals seek the perceived relative safety of this investment. As T-bond prices have been bid up, the yield on these instruments has fallen to historical lows. One must go back in history to the early 1960's to find Treasury bond yields this low.
One characteristic of financial bubbles is their persistence; they can last much longer, and grow substantially larger, than what rationality would dictate. However, this bubble, like all such bubbles, will collapse one day as bond yields rise and prices fall.
We have started to anticipate this trend change by shorting the US Treasury Bond market. We entered a large short position in Treasury bonds on April 27th 2010, and added to the position June 28th 2010. The positions are, of course, underwater already as of this writing; this is what one would expect, since betting against bubbles is always a losing investment in the short term.
There are very few sure things in trading the financial markets; one virtually sure thing at this point is that Treasury Bonds will eventually fall substantially lower than their current prices. We are prepared to wait for that to happen.
The most prominent bubble in financial markets today is the US Treasury Bond. Treasury bond prices in the last few years have seen extraordinary elevations in prices as governments, institutions, and individuals seek the perceived relative safety of this investment. As T-bond prices have been bid up, the yield on these instruments has fallen to historical lows. One must go back in history to the early 1960's to find Treasury bond yields this low.
One characteristic of financial bubbles is their persistence; they can last much longer, and grow substantially larger, than what rationality would dictate. However, this bubble, like all such bubbles, will collapse one day as bond yields rise and prices fall.
We have started to anticipate this trend change by shorting the US Treasury Bond market. We entered a large short position in Treasury bonds on April 27th 2010, and added to the position June 28th 2010. The positions are, of course, underwater already as of this writing; this is what one would expect, since betting against bubbles is always a losing investment in the short term.
There are very few sure things in trading the financial markets; one virtually sure thing at this point is that Treasury Bonds will eventually fall substantially lower than their current prices. We are prepared to wait for that to happen.
# posted by MATT E @ 7:30 PM 
