How Much Lower Can Treasury Yields Go?Jul 05, 2012
After many bold and loud proclamations of doom for U.S. Treasuries, yields have fallen and prices have risen. Is the game in Treasuries almost over or just getting started?
Conventional wisdom tells us that U.S. interest rates have nowhere to go but up. The depressed yields on U.S. Treasuries are trading at historic lows and the Federal Reserve Bank can’t manipulate interest rates below zero percent. How much further can U.S. Treasury yields fall?
Conventional Wisdom is Wrong (again)
A quick look at conventional wisdom about the state of the U.S. Treasury market illustrates how the bond market’s best minds have been badly wrong.
Look no further than Bill Gross, founder of PIMCO, manager of the largest bond mutual fund (Nasdaq: PTTRX) and one of the savviest fixed income investors anywhere.
In 2011, Gross famously proclaimed that U.S. Treasuries offered no upside and it was time to bail. Treasury investors are destined "to get cooked like frogs in an increasingly hot pot of water,” are the exact words he used at Morningstar’s 2011 Investment conference.
Other well-known investors (too many to mention) agreed with Gross and recommended shorting Treasuries or bailing altogether. This mistaken view reached a climax as the U.S. neared its debt ceiling deadline in August 2011.
Meanwhile, ETFguide took an opposite view by writing to its subscribers:
“While losing the coveted AAA-rating is bad, it isn't a total disaster. Even with a downgrade, U.S. debt would still be considered ‘investment grade.’ Our first recommendation is to ignore the noise being spread by major media establishments. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit.
If a debt deal gets completed, how will the U.S. government bond market react? Funds like the iShares Barclays 20+ Yr Treasury Bond ETF (NYSEArca: TLT), ProShares Ultra 20+ Yr ETF (NYSEArca: UBT), ProShares Ultra 7-10 Yr ETF (NYSEArca: UST), Direxion Daily 30 Yr Treasury Bull 3x Shares (NYSEArca: TMF) and other U.S. government bond ETFs would likely have relief rally. And therein lays the potential short-term profit opportunity to take long Treasury positions during today's uncertainty.”
How did it turn out? U.S. Treasury ETFs ended 2011 substantially higher, easily beating stocks (NYSEArca: SPY). UBT was up 72.77%, UST increased 30.76%, TLT jumped 33.96% and TMF soared 109%.
Later that year, Gross issued a rare apology for betting against U.S. Treasuries.
Is this Time Different?
Today, the yield on 10-year Treasuries (NYSEArca: IEF) is around 1.59%. On a relative basis, that yield, while historically low, is still much higher compared to what similar maturing debt from other nations like Japan and Switzerland are yielding. This suggests that U.S. yields can do the unthinkable by falling further. Which ETFs will rise as a result and what are the trigger points for buying/selling?
The July 2012 ETF Profit Strategy Newsletter evaluates a confluence of other factors contributing to distortions in the U.S. Treasury market and how to profit. The Federal Reserve’s extension of Operation Twist through the end of the year is just one factor and the declining creditworthiness of European governments (NYSEArca: FXE) is yet another.
And contrary to what the convention wisdom is saying, the marketplace distortions occurring in the Treasury market could become even more extreme.
Source: Bloomberg, July 2012
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