Are Treasuries Really in a Bubble?

Allen

Posted on Thu 12th Mar, 2009 06:04:07 PM

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We’ve been hearing about a bubble in Treasuries for quite a while. I think it may be timely to sum up the bulls and bears of treasuries.

Pro side: Treasuries are in a bubble.

1) Due to the financial crisis, people have found a safe haven in treasuries and have driven yields of treasuries, especially those with short maturities to near zero. Even the 10-year Treasury note is yielding less than 3% as of writing. Since in the long run, interest rates will have to rise, treasuries are currently in a bubble now.

2) The Obama stimulus package will need hundreds of billions of financing and that demand should push yields higher.

Con side: Treasures are not in a bubble.

1) Treasuries have traditionally been safe havens during times of financial distress. Since the clouds do not appear to be clearing anytime soon, we assume they will continue that function.

2) In the past few decades, consumer demand growth has largely been fueled by debt, which consequently led to a huge increase in manufacturing. With the bubble bursting in 2008, banks have been tightening lending standards and consumers have cut back on borrowing. Which leaves us with huge excess overcapacity in manufacturing in almost every aspect. Therefore, banks have fewer outlets for loans. Combined with the adverse economic environment, they may opt to invest their money in treasuries rather than lend it out.

3) The current Federal Funds Rate is 0.25%. Banks can effectively borrow money at 0.25% and lend it to Uncle Sam for 2.8% if they buy the 10-year treasury note. Who wouldn’t want a free lunch?

4) Despite predictions that the US Dollar will crash, the USD has been remarkably strong. European, British and other economies are doing poorly, weighing on their currency. Some reports suggest that European banks are in worse trouble than US banks, which is a slap in the face for the Euro.

5) Some countries, like Britain, have recently declared experiments in quantitative easing. Which is, in short, the central bank printing lots of money to buy commercial paper, bonds and other types of securities. Japan has even mentioned intentions of buying stocks to prop up the stock market.

6) Deflation: Due to all the destruction in debt and wealth, money supply is not growing despite the Fed’s efforts to pump money into the financial system., and deflation instead of inflation is taking hold. In a deflationary environment, even a T-bond that yields 1% would be yielding a positive real interest rate.

7) During 2008, US government bonds were one of the few assets that performed well. The asset management community has suffered heavy losses in 2008 and is eager to look for an investment that seems safe. Since the only thing that gives a perception of being safe is an asset not losing value, treasuries have accomplished that task pretty well. Better a 3% in 10 year treasuries than a 30% loss in the stock market, the reasoning goes.

Finally, almost everyone is calling it a bubble. That may be suggestive that the current bubble is not going to bust yet.

To sum up, I personally believe that Treasuries will remain with low yields for a relatively long period of time. Eventually though, in the long run, yields will rise when the economy truly recovers.. However, Japanese government bonds have remained low for years.

This was a guest post by StockTradingToGo Community member Allen. Other recent posts from this author:

• 6 Reasons Policy Makers Won’t Market Bubbles
• 7 Key Reasons Why Bubbles Form
• Four Must Avoid Investment for New Investors
• Three Big Reasons to Buy Gold
• Comparing Japan’s Lost Decade to the Current US Recession
• 4 Great Gold Myths Debunked