Shut-up, WSJ: "Bond Bubble" edition

There has been a lot of noise in the blogosphere about the "bond bubble" (1) (2) lately. For what it's worth, I don't think there is so much a bond bubble as there is a system awash in liquidity that has to go somewhere. Some money is chasing momentum, some is chasing income, some is chasing yield that has more stability than equities can provide. I do think rates are absurdly low, but that's what happens in deflationary environments. The JGB bubble has been a "no-brainer" short for 15 years, but that trade has been a consistent loser for just as long. In general, I think bonds have limited potential to enter "bubble" territory right now because their value has a natural cap (that they trend to as maturity approaches) and because bubbles--in my mind at least--require massive amounts of credit to finance the purchases of the asset in a bubble, and that demand for loans would, you know, be reflected in higher interest rates that would halt the appreciation of bonds.

I guess you could argue that that's not true because the purchases could be financed via over-night money from the Fed, but banks are holding excess reserves. You could say that this is all being financed by the shadow banks, but that's not true either. So, shut-up, Evan.

Evan Newmark writes:

And while there’s no guarantee that the yield on the 10-year Treasury won’t fall further to 2.4% or 2.2%, I wonder, “Who will be buying those bonds?”
That’s not at all clear – because today’s buyers of “long-term” government bonds are not really “long-term” bond buyers.

The Fed is buying Treasurys to tinker with the money supply.

Yup, it's called the FOMC. That's what they do. There's also that whole ABS facility re-investment thing.

China is buying them to tinker with its currency.

Yup, that's what central banks usually do with foreign reserves, buy the sovereign.

And U.S. banks are buying them to tinker with their earnings.

Yup, banks do indeed lend money. Since consumers don't want any, they are lending it to the government.

So who is buying a 10-year Treasury yielding 2.64% intending to hold it for a decade? Some retail investors, I suppose.

Is this a joke?

Also, you seem to have missed the point that the yield-curve is pretty damn steep right now, which is very important. Let me put it this way, the OTR 10Y is yielding 260bp at the time of this writing. The OTR 7Y is yielding 198bp. When the yield curve is upward-sloping, like it is right now, every year I hold a bond, the yield the market requires on it lowers. That means that if I buy a 10Y today, the 7Y yield could rise 62 basis points over the next 3 years and I still would have no capital losses.

But the Treasury market is now acting like any speculative market. Forget fundamentals. Buyers are buying into it because prices are going up. The 10-year Treasury isn’t a “10 year” instrument. It’s a “high quality” piece of paper that gives a little extra yield. Hold it today. Flip it tomorrow.

And just what happens when a GDP number comes in hotter than expected and there is no one to flip it to at a higher price? Ask the investors who were buying Yahoo!, a “high quality” internet stock, at $108 in late 1999.

Yup, that's exactly how it works with a positively sloped yield curve. We just went over this, but I'll get into the mechanics so you understand how it work: Let's say I buy a 10Y today at 260bp, if yields stay put, I would make $78 in coupons, and $40 in capital gains! Now, consider the 5Y yield is 141bp. The positive slope means that you have wiggle-room for yields to go up before you ever face capital losses.

The TBT, you’ll recall, is the ProShares UltraShort 20+ Year Treasury ETF. It’s a leveraged bet that prices of long-term U.S. government bonds will fall and yields will rise.

I started buying the TBT back in late May – and have continued to buy more as its price has dropped. Most Wall Street traders will tell you not to “average down” on a losing position. Remember, that thing about trends?

Well, congratulations to you, mouth-breather. As I commented on the article--under my real name, mind you--"the leveraged products are long deltas at the expense of gamma (and have a non-trivial expense). Even if you are right about the direction, a little volatility could destroy your returns. A less inefficient bet would be to short the opposing 2x ... in my opinion, the smartest thing to do given your outlook would have been simply to buy some floaters."

Remember The Laws of the Land! Any time you are using one of those products you are fighting a battle against entropy, and that’s just not the kind of battle  I’d want to fight.