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Saturday, December 20, 2008

January 15th Target for Ten Year U.S. Treasury Play

With each passing day, the 10 year U.S. Treasury continues to set all time lows on the interest rate it pays. It closed Friday at paying 2.12% just off the low of 2.07% it reached on Thursday. That means that someone buying a new 10 year Treasury bond would receive an annual interest rate of only 2.12% if they kept the bond for the full ten year term.

As I have explained often, the U.S. Treasury bond is how our government borrows money. The Ten Year U.S. Treasury is the one most often used by the government to borrow. It is currently paying the lowest interest ever mostly because of the dire economic news we have been hearing ad nausea. I have surmised though that for the most part the bad economic news is just an excuse for speculators to drive down the rate. That it is now speculative, in my opinion, is the main reason why I am bullish on playing it the other way. All speculative markets crash and I believe the crash is coming soon.

The other reason has to do with the plans of President Designate Barack Obama.

President-elect Barack Obama's team and congressional staff are scrambling to come up with details of a plan to pump up the droopy economy with $650 billion or more in government spending over the next few years.

The aides met in the basement of the Capitol on Friday to devise ways to pump public money into science, energy, education, health care and infrastructure programs, as well as to help the poor and unemployed.

They hope unleashing a torrent of spending in the near term will create jobs and lift the economy.

But the amounts of money under consideration are so enormous - larger than either the Pentagon's annual budget or the entire domestic budget passed each year by Congress - that it's likely to prove challenging to spend so much without wasting taxpayer dollars.

Obama and his Democratic allies in Congress want to enact the still-emerging plan as soon as possible after he takes office on Jan. 20. They hope to agree on an outline by Christmas, said a House Democratic leadership aide, who requested anonymity to discuss the ongoing talks

President Obama will want to spend, spend a lot, and spend it quickly. Since, our government is already running a deficit, he will have to borrow, borrow a lot, and borrow it quickly in order to spend it. It will likely be no more than two or three days before President Obam is going to the Treasury bond market for lots of new cash.

This sets up a dichotomy that I believe is an albatross. Until then, it is very likely that the Ten Year will continue to shoot down. It will reach levels that are unheard of. It may be paying in the one percents by the time he reaches office. By about January 15th, the rate on the ten year will likely have broken through new records several more times. Then, within a week, the President will borrow hundreds of billions of Dollars from the Treasury bond market. In other words, he will want hundreds of billions of new Dollars from the market at rates that are at record lows. I firmly believe that the market will say no way. The market will say, in my opinion, that if the U.S. wants to borrow hundreds of billions of more Dollars that it won't do it at 1.9% but rather 3.5%, or 4%, or even 4.5%. I believe you simply cannot ask for this much new money from the debt market at rates this low. The market will adjust the rates to account for all of this new borrowing.

If you were to buy a call option on the U.S. Treasury ( as I have recommended though I will repeat that I am not an investment advisor and no investment advice should be taken at face value. Everyone's situation is different) A call option is an investment tool that allows you to play a security if you think it will get worse. In this case, a call option would be the play if you think the rate would go up. The yield would in fact go down because they have an inverse relationship. If you were to do it on January 15th, it would allow you to get the option when rates are at unprecedented levels. It would also allow you to buy it right before the market dynamic changed dramatically.

Of course, the economy could be so overwhelmingly bad that it overwhelms everything I have said. While this is always a possibility and no investment is of course a sure thing, I believe that the Ten Year can't really go any lower. The short term rates are already trading at below one tenth of one percent. They certainly can't go much lower. The ten year has already responded in an unprecedented way to the bad news from the economy. I believe that much of this response has been driven by speculators. Now, these same speculators will drive it up based on a new dynamic.

1 comment:

MacD said...

I thought you buy the call options on the TNX when you think rates are going to go up (not Puts)??