Yields in Treasury bonds have probably hit their lows and from now on, interest rates will move up and make bond prices fall.
Since April, rates have consistently moved lower. The two-year and seven-year Treasury yields reached record lows, surpassing those achieved at the peak of the financial crisis when fear and doom had taken control of the market.
Rates have steadily moved lower because of the major sell-off in the markets caused by the flash crash and the European debt crisis. These events made worried investors leave the stock market and flock into the “safety” of U.S. government debt.
Also, big hedge funds and momentum-chasing speculators joined the trend, empowering the rise in Treasury prices.
From a fundamental perspective, this trade doesn’t make much sense since the United States is one of the worst offenders regarding government debt. With a $13.6 trillion public debt, $110 trillion in unfunded liabilities and a 93.25 percent debt-to-GDP ratio, prospects for Treasuries aren’t very bright.
Another factor that the media has used to explain the fall in yields and rise in Treasuries is a new quantitative-easing program, in which the Federal Reserve prints dollars to buy back Treasury debt in order to help the weakening economic recovery.
I believe they are mistaken. Yields actually went up -- and not down -- when the Fed started the first quantitative-easing program. They began to fall when the program stopped.
A new quantitative-easing program will only cause the yields to rise as the dollar is devalued and investors seek a higher yield in their Treasuries to compensate a weaker currency.
Even if the Fed doesn’t launch another monetary-stimulus program, the rates should begin to rise anyhow as the massive debt that the U.S. Treasury emits every month increases the supply of Treasuries and thus should cause the fall in their prices.
From a more technical point of view, Treasuries are very overbought and forming a top. The commitment of traders for the 10-year Treasury shows that commercial hedgers are net short and large speculators net long, which is a contrarian sell signal.
Sentiment in speculators is very bullish toward Treasuries in the options market with the put/call ratio in the bottom of the range. This normally signals a top for most financial instruments.
(Disclosure: I’m short the 10-year Treasury bond.)
About the Author: Victor Riesco
Victor Riesco, a financial analyst and trader in Santiago, Chile, works as an independent adviser and educator and operates a brokerage and trading business for local investors. Click Here
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