Saturday, March 10, 2012



One of the best trades so far this year has been a bet against long maturity treasury bonds, i.e., a bet on higher long term interest rates. The yield on the 10 year treasury, at 2.03%, is up 15 basis points (“bps”) for the calendar year while the yield on the 30 year treasury, at 3.18%, is up a nearly staggering 29 basis points for the year.

Despite these dramatic increases in interest rates, yours truly thinks that higher rates, and probably substantially (50-100 bps at least) higher rates, are in the cards, certainly by year end. Why do I say this? This prognostication has little or nothing to do with the prospects for a QE3. It is impossible to get inside the head of Obsequious Ben Bernanke and his sycophants on the FOMC. That having been said, because of my feelings about the “genuineness” of this economic recovery and the reasons I refer to Dr. Bernanke as Obsequious Ben, I suspect we will see something like QE3, perhaps with a milder moniker. But it doesn’t really matter; rates will go up if the Fed does nothing to keep them from going up and rates will go up if, perhaps especially if, the Fed does everything it can to keep them from going up. Why?

Either this economy is going to recover, putting natural upward pressure on real rates that the Fed cannot, and should not (I know; this has never stopped Obsequious Ben in the past from putting the big hurt on savers.), temper and/or inflation will finally make its presence known (in government statistics; inflation’s presence has been very well known in our daily lives for years now), putting irresistible upward pressure on nominal rates. “Irresistible” is probably not a strong enough word; any efforts on the part of the Fed to keep rates down in the face of inflationary pressure, or even pressure on real rates, will be more than futile; they will be glaringly counterproductive.

Interestingly, despite holding this very firm conviction on the direction of nominal rates, I remain very long treasury inflation protected securities (“TIPS”); in one form or another, TIPS comprise well over half my total portfolio and over 70% of one of my, for lack of a better term, sub-portfolios. So it’s pretty clear that I think the upward pressure on nominal rates will come from inflation rather than economic growth. So far this year, at least, the market seems to agree with me; while, as I said before, conventional 30 years and 10 years have increased in yield 29 and 15 bps respectively, 30 year TIP yields have increased only 4 bps while 10 year TIP yields have fallen 15 bps. The implied inflation assumptions for the 10 and 30 years are 2.30% and 2.39% respectively, well below current headline CPI of 2.9% and a bet I will take all day. The ETF TIP is up 1.68% for the year.

Of course, some kind of financial disaster, a’ la’ Lehman, driving investors into the relative safety of U.S. treasuries, could turn this prediction on its head. Still, one wonders if even the next financial shipwreck would overcome, in any but the shortest of runs, the growing realization on the part of investors, especially foreign investors, that the only way out of our debt problems (The cognoscenti continue to insist that what we experienced was a housing problem rather than a debt problem, an insistence that makes yours truly even more sullen regarding the economic and financial outlook.) is inflation, with obvious ramifications for conventional treasuries.

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