Jan. 17, 2014
U.S. Treasuries are starting to look interesting, and the market may be ripe up for a nice little rally in the coming quarter.
Professional traders and investors have spent much of the last few weeks and months positioning themselves for the withdrawal of Fed stimulus, leaving them significantly underweight their duration benchmarks if not outright short US interest rates exposure. The Stone & McCarthy investor survey recently showed that money managers are shorter than they’ve been since 2008, while net non-commercial investor positioning in treasury futures indicate an overwhelming short bias among speculators as well (Chart 1).
But the tapering of the Fed’s asset purchases will be at least partially offset by a decline in net Treasury issuance in 2014 due to reductions in the federal budget deficit. To wit, the first installment of the taper reduced purchases by only $10 billion per month, while net Treasury issuance is expected to decline by closer to $140 billion in 2014, leaving available net new supply slightly lower so far this year than last. A further tapering of Fed purchases will of course change that calculus, but one should be careful not to overestimate its impact within the broader context of overall supply.
Besides, the last two times the Fed stopped buying Treasuries, at the end of QE1 in June 2010 and the end of QE2 a year later, the market responded to the increase in net available supply by rallying sharply (Chart 2).
Valuations, meanwhile, are also starting to look attractive, especially on a relative basis, providing discretionary global investors with a sound reason to buy Treasuries. At over 2.80%, the yield on tens now exceeds the dividend yield of the S&P500 by nearly 100 basis points, providing balanced investors with a valuable income advantage as well as a hedge against expensive equity valuations. The yield on tens now also exceeds that of ten-year German bunds by more than 100 basis points, a yield spread not seen since 2006 and surpassed on only a few rare occasions over the past twenty years (Chart 3).
Finally, when compared to the real, inflation-adjusted yields available in other large, liquid government bond markets, ours once again look attractive (Chart 4), making them particularly appealing to global reserve managers who continue to accumulate dollars in their reserve accounts.
If these and other large international buyers help pick up the Fed’s slack in the next few weeks and months, the great post-taper selloff of 2014 might not show up at all, leaving domestic money managers and speculators anxious to cover their expensive, negative-carry shorts.
I currently have a small core long position in Tens, and remain a strategic buyer of dips.
Happy Trading,
D
