Why Capital May Finally Run Out of the Treasury Market This Year

By Simit Patel of InformedTrades.com 

(June 4th, 2012) It’s no secret that those who have been short US Treasury bonds over the past few years have not fared well. In the wake of the 2008 financial crisis, bond prices have soared; the rationale has been that with the US in a deep recession and the Eurozone mired in its own credit crisis, US Treasuries remain a safe investment.

It seems, however, that the situation may finally be reversing — and that bond market could be headed south. First, let’s take a look at the technicals: below is a chart of TLT, the ETF tracking long-dated US Treasury bonds. The volume spike coupled with a steepening of price acceleration over the past few days suggests the potential that the rally in Treasuries may be reaching a point of exhaustion. For speculators, this may be a safe time to try shorting the bond market.

Fundamentally, the story bond market investors have clung to for years remains the same: the US is running twin deficits, which means it is spending more than it takes in via taxes — and thus needs to continue issuing more debt — and is also importing more than it is exporting. Budget deficits demand more debt and put more strain on the bond market; trade deficits, on the other hand, have the effect of weakening the currency, which in turn may cause bond market investors to be wary.

The situation with the twin deficits in the US may especially be coming to a head when one considers that many bonds are maturing at the end of the year. According to Bloomberg, the world’s governments face 7.6 trillion in bond payments due by the end of 2012. If the nation-state governments of the world are not able to pay the bill, it could lead to a panic out of all bond markets. As for where the capital will go, most of those concerned about bonds suspect a flight to precious metals, commodities, and perhaps dividend-yielding equities.

On the flip side, those who remain bullish on the bond market argue that the US Federal Reserve, the nation’s central bank, can simply print money and buy bonds — and thus keep bond prices propped up. Moreover, doing so can invite short-term speculators to enter the market on the Fed’s strength, thus creating further momentum in the bond market. Many argue that this situation has been occurring over the past 10 years as a result of various stimulus efforts by the Fed, and as the Fed shows no signs of relenting — particularly in an election year — the situation may persist. If it does, shorting bonds will remain a losing proposition.

Technical traders may find it advantageous to consider the matter from the perspective of risk and reward. A stop loss at 132, with a target of 90, would provide traders with a reward/risk ratio of about 20:1. From this perspective, shorting Treasury bonds now may be a fantastic opportunity for the patient investor who understands the insolvency the US Treasury faces.

InformedTrades is a site geared towards helping individuals learn to trade.  For more articles from Simit Patel visit InformedTrades.com.