Who is left to buy?

Anyone who owns Treasury bonds has to ask themselves that question. Or maybe a better question is, “Who’s stupid enough to buy?”

The yield on the 10-year Treasury note dipped below 3% last week. (The 10-year Treasury is a good “benchmark” for interest rates.) Meanwhile, inflation is running at about 6%. So buyers of 10-year Treasurys are locking in a 3% annual loss of purchasing power – before taxes.

[ad#Google Adsense 336×280-IA]The Chinese aren’t stupid. They’ve been net sellers of U.S. Treasury debt for most of the past year.

Japan isn’t stupid, either. It’s on the sell side, too.

Indeed, the only one stupid enough to buy low-yielding U.S. Treasury debt is the U.S. itself. Over the past nine months, the Federal Reserve has increased its holdings of Treasury notes and bonds from $720 billion to more than $1.4 trillion.

Of course, that was the whole point of the second quantitative easing program (QE2), wasn’t it? Let’s have the Fed buy up our own Treasury obligations. If we keep Treasury prices artificially high, we can keep interest rates artificially low.

But QE2 ends in two weeks. So again, we have to ask, “Who is left to buy?”

There will always be some demand coming from pension funds and other institutions that must hold a certain percentage of their assets in U.S. Treasury obligations. And any short-term hiccups in the stock market will send some stock investors running for the perceived safety of Treasury bonds.

But with an ever-increasing supply of new bonds and shrinking demand, bond prices really have only one way to go…

Down.

When bond prices drop, the yield will soar. And with the yield on the 30-year Treasury bond dropping below 4.2% last week, we’re now looking at the second-best time in the past 40 years to sell the government bond market short.

The best time was last September, when the yield on the 30-year Treasury bond dropped as low as 3.55%.

In my Advanced Income newsletter, we took advantage of the situation by buying TBT, a leveraged bet against long-term Treasury prices, and selling covered calls against it.

TBT moves higher as bond prices fall. So as bond prices fell and TBT rallied through the end of last year, we did well on the trade. We earned 10% in just four months. (Our uncovered put trade did even better – earning 31% over the same period.)

[ad#article-bottom]After we exited the position, things reversed. Bond prices started to rise and yields fell. The logic of the short bond trade didn’t change, but the price action did.

You see, from September through December, interest rates rose too fast, too soon. Being short Treasury bonds became a popular trade. Too popular. So the market did what it always does to popular trades. It went the other way.

That, combined with the Fed’s constant bid beneath bond prices, has forced bond prices higher and yields lower over the past few months.

But it’s temporary. Interest rates are going higher now – which means bond prices are going lower. The basic laws of supply and demand require it. Any bets on that outcome will make money over the next few months.

If there was ever a “pound the table” moment in the financial markets, this is it. Get out of Treasury bonds now. They are going lower.

Best regards and good trading,

— Jeff Clark

[ad#jack p.s.]

Source:  The Growth Stock Wire