Revisiting the short long-bond trade

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Erik T.'s picture
Erik T.
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Revisiting the short long-bond trade

Many readers of this site including myself have followed Chris Martenson's advice (in a recent subscriber-only Martenson report) and hold short positions against long-dated treasury bonds. Clearly, the world changed in a dramatic way this past week, when the Fed pushed the Fire button on Quantative Easing, announcing its intention to monetize debt by buying $300bn of long-dated treasuries. The purpose of this thread is to revisit the rationale for the short long-bond trade (noting that many pros covered their shorts on Wednesday's news).

I'm as confident as ever that in the long run, the long bond has to collapse and yields have to blow out on the upside. As China has commented publicly, foreign holders of treasury debt are watching in horror as our government undertakes some of the greatest financial blunders in recorded history. I thought Jim Puplava was particularly insightful in this week's Financial Sense Newshour, when he opined that investing in U.S. treasuries never made economic sense for countries like China on its own merits. Puplava explains that the reason the Chinese are so willing to finance the U.S. is that they are financing the purchase of their goods, just as a car dealer will always have a finance department because they want to make it easy for you to buy their cars. But as China (and others) watch current political activity in the U.S., their desire to loan money to an insolvent government at 3% interest for 30 years for the sake of financing our welfare, health care, and other social entitlements is exactly zero. If fo

On the other hand, being on the opposite side of a speculative trade from a counter-party who has the legal right to print all the money they want to force the market in their favor is investor's suicide. Thinking that low yields on long-dated treasuries can't last forever is still prudent, IMHO. But thinking that the U.S. Gov't is unable to prop up prices all they want and thus collapse yields would be a fool's bet.

It seems to me that the key to this trade is trying to figure out the Fed's target rate for long-dated treasuries. If you knew that with accuracy, the trade would be easy: Go long now, wait for the Fed to achieve its target rate, then go short and wait for the inevitable. Knowing their exact target is probably impossible, but an analysis of residential mortgage benchmark indices should make it possible to make educated guesses.

I'm struggling with what to do here. I'm currently short both 10-year and 30-year treasury futures, and there is no doubt in my mind that the prices will go lower. Some day. It also seems pretty clear that the Fed is going to prop them up between now and then. I'm tempted to cover my shorts, take some profits, and wait for 140+ on the 30-yr futures contract (now at 129), then go short again at that point. But that's market timing at its extreme, and runs the risk of missing the big move if the fed backs off its policy (brief moments of intelligence in Washington is still plausible, right?).

It seems to me like the key to this is understanding what their target rate is for mortgage borrowing (all the treasury buying appears to me to be motivated by their desire to pull down mortgage rates). Anybody seen any definitive statements that might offer insight into what their targets are, and/or what timeframes they're aiming for?

What are the rest of you who were in this trade thinking? Did you cover on Wednesday's news, or stay the course? Would you look at a short-term (smallish) spike in treasury prices as a selling opportunity, or wait it out until the Fed slows its buying spree?

Erik

 

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cmartenson
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Re: Revisiting the short long-bond trade
ErikTownsend wrote:

Many readers of this site including myself have followed Chris Martenson's advice (in a recent subscriber-only Martenson report) and hold short positions against long-dated treasury bonds. Clearly, the world changed in a dramatic way this past week, when the Fed pushed the Fire button on Quantative Easing, announcing its intention to monetize debt by buying $300bn of long-dated treasuries. The purpose of this thread is to revisit the rationale for the short long-bond trade (noting that many pros covered their shorts on Wednesday's news). 

Oh, hey, hold on there.

I never gave that "advice" that you ascribe to me.

My last communication on the issue (12/17/08) was that I was considering the trade and would let people know when I personally pulled the trigger.  I wish had when I wrote that report because the ten-year was at 2.1%.  However, I was not paying close enough attention and by the time I turned my gaze on the ten-year it had already breached the neckline of the chart I was following, so I did not place the trade.

Many people are interested in my portfolio and how I've positioned myself, but this is a very different proposition from me giving individual trading advice, which I do not do.

Just want to be clear on that.

1) I will always post my trades.

2) My trades are not trading advice.

I hope this is clear.


One reason I am still sitting on the sidelines, besides missing my price, is that Japan is now more than a decade into quantitative easing and has long bonds that trade at abysmally low levels.  So the lesson there is that a determined government can control the prices of key financial products for a very long time.

The risks for the US, or the wild-cards if you will, are that the US is a massive debtor nation, and dollar the reserve currency, where Japan and the Yen were neither, respectively.


On another note,  I am personally dialing up my "alternative investments" here and seriously looking at buying some productive land.  I may have to swap out some gold and silver to do that, but that's where my intuition lies right now.

Hopefully my "spidey senses" are wrong here, but something is just flat-out not right with our financial markets and I cannot know what that is at this time because I am not an insider.

At several verifiable points in the past when I've felt this way (usually due to some combination of financial market cross-currents that do not fit normal patterns or even make any logical sense) later news reports have validated how close to the mark I was.  Last October is one recent example where I was urgently cautioning people to protect against a systemic banking failure and some months later we found out (at least according to a British VIP) that we were hours away from a melt-down at that time.

I guess my base proposition these days is that when I get these feelings I just go with them now, and ask questions later.

 

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Lemonyellowschwin
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Re: Revisiting the short long-bond trade

What are your spidey senses telling you Chris?  Anything more specific than that your senses are tingling?

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Erik T.
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Re: Revisiting the short long-bond trade

Sorry, Chris... My bad!

What I should have said is that many of us on this site are currently engaged in or considering the short long-bond trade, which Chris mentioned as an interesting possibility in a recent Martenson report. My sincere apologies for the mis-statement.

That said, I'm still very keen to hear other opinions on how the recent news affects the prudence of this trade. I have already booked significant profits on this trade (I sold my first few 30yr contracts at 140), and am very tempted to take the profits and wait for the Fed to bid prices up a bit before re-entering the short...

Erik

 

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Re: Revisiting the short long-bond trade

Erik,

If it helps, I'm in the same boat that you are with this trade. The move last week hurt, but I try very hard not to trade on emotion, so I stayed with it. I believe the best reason to stay in this trade is the fact that everybody is so bullish because of the Feds action. But once I start to see losses, it will be hard to keep my contrarian stance. Most likely, I will sell right before the greatest fall in bond prices that the country has ever seen. I'll let you know when I sell if you want to double-up on your position (ha ha).

I think Dr. Martenson's move toward tangible assets (land) is a good idea. Who needs the stress of these crazy markets anymore!

Sorry I couldn't be more help, but its obvious by your post that you know more about this than me. My trading strategy is very simple: when markets get cocky (extremely bullish), I always try to take a short position. Its not the most elaborate strategy, but with human nature what it is, it makes me more money than it takes from me. But with the Fed now so directly involved in this market, its feeling awfully lonely on this side of the trade.

Jeff 

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plantguy90
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Re: Revisiting the short long-bond trade

I love shorting the long bond.  Right now its a timing trade for me, for obvious reasons.  I think those who are overcommitted to long bonds are quietly trying to get out, because you are fighting the unstoppable printing press.  I stay very short-term in my thinking, as bonds are almost at a ceiling but being propped up magically.  Saying you dont want to miss the boat indicates overallocation.  Take some money off the table, and enjoy it when you are correct.  TG is talking today, and that a good day for shorts ; )

 

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Woodman
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Re: Revisiting the short long-bond trade

Thanks to you all for sharing your positions.  It's not clear to a simple person like me yet whether yields will blow out in 1 year or 10 years, and I don't have much money to invest anyway so I remain on the "sidelines" until there is a clearer trend.  But I already have a bit of land in a comfortable location, so my "investment" focus for now is increasing the energy efficiency (insulation, passive solar), and increasing the season and size of garden production, and spreading awareness to others of current issues. 

Erik T.'s picture
Erik T.
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Re: Revisiting the short long-bond trade

Holy cow! I almost bailed out of this trade (short USM9 and TYM9 futures) and booked my profits yesterday. I figured that getting into a staying power contest with an opponent (the Fed) licensed to print was about as bright as being the villain in an old James Bond movie (licensed to kill).

The notion that the market moved lower in the face of Fed buying leaves me speechless. (See Karl Denninger "End Game" thread elsewhere in forums). Sure, there's the old adage of buy on the rumor and sell on the news, but considering they only announced their intention to start buying today one day ago, I was expecting at least a little up-move. This really scares me.

As I see it, what's happening is:

  1. Chinese Premier Wen diplomatically suggested that the USA should be a little more careful with its fiscal policy if it wants foreign investors to continue funding this folly.
  2. The whole rest of the world watched in anticipation, hoping Bernanke would have the good sense to heed this entirely reasonable warning.
  3. The Fed thumbed its nose at China and the rest of the world by announcing an unprecedented, reckless QE program.
  4. The whole world recognized on that day that investing in the USA was a sucker bet. This was probably a seminal event that marked the beginning of what could eventually become a sovereign collapse.
  5. Several other prominent US officials made public comments to the effect, "Who does China think it is to try to tell us what to do?". The Chinese and the rest of the world got the message loud and clear: America has no intention of treating its foreign creditors responsibly.
  6. Foreign governments ain't stupid. They know better to bail out of treasuries en masse and start a snowball effect that would compromise their own interests. Instead they put their best minds to work on the question "If we want to bail out of US debt completely but don't want to panic the market while doing it, what's our best strategy to sneak out of as much of this overpriced debt as we can without anyone noticing?"
  7. Part of the answer was to be ready to sell when Bernanke starts buying. They know Ben won't hesitate to recklessly add more and more money to his side of the trade in an effort to push bond prices up (i.e. yields down). So their strategy is to sell into the Fed's buying. However much the Fed is willing to buy, the foreigners will sell to them, striving to keep prices where they are. The foreigners know that if they allow Bernanke's efforts to work (push yields down), they are just leaving money on the table that could have bailed them out of some toxic US treasury debt. And they know that if they sell too aggressively they will panic the market. So they just sell as much as Ben will buy, keeping yields and prices stable as China's stupid investment mistakes are transferred from its government to the American taxpayer.

I can't decide what to do with my short position. I was going to bank my profits, wait for Ben to bid up the prices, then get back into the short at a higher level. If we hit 140 on the 30-yr futures again, I was going to jump in heavy.

But now I'm scared to abandon the short. If this keeps going the way I think it's going, eventually the world will wise up to what [I speculate that] China is doing, and the really big collapse will begin. When it does, it's going to be ugly.

So I think my plan is to hold onto my current short position, and then systematically increase my exposure if Ben is successful in bidding up prices temporarily. I'm reminded of the story of George Soros making a killing betting against the Bank of England on what was actually a somewhat similar situation. But I don't have anything close to Soros' staying power.

Thoughts?

Erik

 

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machinehead
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Re: Her majesty can't give it away on Eleventh Avenue

Trouble in the sceptered isle -- whose open 'money printing' policies are being copied here inna United Snakes --

For the first time in almost seven years, the U.K. couldn’t
find enough buyers for one of its debt sales when it offered
1.75 billion pounds ($2.55 billion) of bonds yesterday. The
yield on 10-year gilts rose after the sale by as much as 20
basis points, or 0.2 percentage point, to 3.53 percent, the
highest since March 5.

The failure came a day after [BOE Guv Mervyn] King said the government needs
to be “cautious about going further in using discretionary
measures” to expand government deficits as it tries to pull the
economy out of a recession. Robert Stheeman, head of the U.K.’s
Debt Management Office, which runs the bond auctions, says it
wasn’t able to attract enough bids partly because of the Bank of
England’s efforts to lower yields through debt purchases.

“Yields at these levels are not at all attractive,”
Stheeman, chief executive officer of the Debt Management Office,
said yesterday in an interview in London. “Yields have shifted
downward. Why have they shifted down? It’s partly because of the
Bank of England’s announcement about quantitative easing.” Investors say both are to blame for the failed debt sale.

Gilts have “only one buyer and that’s Mervyn King,” said
John Anderson, a money manager who oversees about $3 billion in
pound-denominated assets at Rensburg Fund Management in London.
“You don’t need to look anywhere beyond that. Make your mind
up, please, government. Do you want to buy gilts or do you want
to sell them? You can’t do both.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aIKSUe1a8Rpg&refer=home

Yes, make up your mind, dear guvvy. Because selling bonds to your
own damned self is contrary to nature ... the monetary equivalent of
auto-fellatio, as it were.

The monster spike down in yield on last week's Fed announcement,
followed by rises ever single day afterward, was one of those classic
'sell the news' trades. Half of the spike down has already been
retraced in five trading days.

All indications are that Usgov, having declared that 'deficits don't
matter' or 'we owe it to our goodselves' or some such gibberish, has embarked
on an out-of-control deficit spending spree. The Fed, with a $2
trillion balance sheet, is simply not big enough to finance
trillion-dollar deficits as far as the eye can see. Their $300 billion
shot across the bow, like Tarp I, was just a down payment on how much
they would have to spend to really peg this market. And if they printed
that much -- say a trillion in Treasurys alone -- hyperinflation would result.

The Fed tried to peg long rates back in the Fifties -- it was called
(I kid you not) Operation Twist. I guess they moved on to Operation
Frug, or Operation Watusi, cuz it didn't work. Benny Bankpanke was
soda-jerkin' at that ancient sock-hop and shoulda had a clue.

My main comment on short trades is not to overleverage, because
bonds trade choppily and don't trend very consistently. Why not take
half of profits, and leave the other half on. Both ETFs and mutual
funds are available which hold short Treasury positions. One can
purchase these funds and ride the bonds down for years to come. Whereas
a short futures position has to be managed more intensely. Effectively
in these funds, they manage the short futures for you behind the
scenes.

 

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plantguy90
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Re: Revisiting the short long-bond trade

Ok, question for all you UST long bond haters out there, whats China's new belligerency towards the dollar going to do to our favorite trade?

Erik T.'s picture
Erik T.
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Re: Revisiting the short long-bond trade

China's belligerency??? Care to elaborate?

In my opinion, China has been remarkably subdued and gentle in their attitude. The US is basically telling it's largest creditor, "Screw you guys. We're America and we'll do whatever we want, reasonable or otherwise, and you don't have to like it".

Belligerence is the right word, but IMHO it's the Fed that is exhibiting it. I think what you're really asking is what effect the United States' shocking belligerence toward China and the rest of the world will have. The answer is now clear: there is a major move afoot to replace the dollar as the world's reserve currency. This may have short-term upside implications for long bond prices because it will force the US to continue to monetize. But in the long run, the dollar will collapse and treasury yields will blow out as prices collapse.

Erik

 

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plantguy90
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Re: Revisiting the short long-bond trade

Just saw where the Fed owns more UST than anyone else; now how does that work?  The Fed is privately owned by the same cabal that is getting the bailouts, I wouldn't think their shareholder equity in the Fed really matters from an investment standpoint.  But at what point does lending money to oneself no longer work?  When everyone else leaves the table, right?  But no one is leaving, in fact they are buying more.  And its not just the Chinese.  

Plus I dont see how the SDR which still comprises of the dollar is a true break from the dollar; this is all too much for my brain.

Erik, I just meant belligerent in the tone the China Central bank guy now takes; its very un-Chinese of him.  You're right, he's sick of it.

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plantguy90
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Re: Revisiting the short long-bond trade

After seeing CM's new report about SS insolvency, and US Bond market is at new highs, its like the entire audience is in a trance, believing that the magician did make the elephant disappear.  Odd.

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plantguy90
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Re: Revisiting the short long-bond trade

Ya can't keep a good yield down!Wink

Erik T.'s picture
Erik T.
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Re: Revisiting the short long-bond trade

I covered my ten-year short yesterday on a brief bit of weakness that brought the June contract down to 122. I'm still wrestling with whether to bail out of the 30yr short. The fundamentals are better than ever, but it seems that Ben is going to do whatever it takes to push the trade against me, at least so long as his thin-air dollars last.

Erik

 

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plantguy90
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Re: Revisiting the short long-bond trade

I havent a clue about the pricing and leverage of futures, but it would seem that betting against Ben is getting a bit dangerous.  Some of the recent bond trading comments from briefing.com have been absolutely hilarious, about how bond pricing can only be maintained at these levels by the big guy; yet there is still magical belief in the big guy and his paper money.  Its also odd how T-bonds still trade up from some safe haven sentiment.  As long as Big guy is throwing in his chips in his effort to lower the lending rate for everyone, you have to imagine new trading levels will exist for a while.  I am expecting lower entry points for sure in the short term.  I may go long for a quick ride before I short again. 

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