Friday, February 13, 2009

The bubble in TBT

Just a few weeks ago, a number of commentators were calling the Treasury bond market a bubble. The 10-year Treasury had fallen to nearly 2.00%, and the 30-year bond had fallen to 2.50%. But since that time, the 30-year Treasury has risen by 100bps, representing a 19% decline in price.

Now if you really want to find a bubble, try TBT, the ProShares UltraShort 20+ Treasury ETF. This fund is designed to delivery -200% of the return of the 20-year and longer segment of the U.S. Treasury market.

First take a look at the shares outstanding in TBT. This is an excellent proxy for how popular a short US Treasury trade has become.

What's one of the conditions for a bubble? Parabolic increases in demand? The outstanding shares in this ETF has gone from about 7 million shares on 10/31 to nearly 63 million shares now.

Treasury bonds should be hitting new lows in yield. Economic and liquidity conditions are as bad as its been since the Depression. Deflation is a more serious threat than its been since that same time. Why shouldn't interest rates fall to record lows? Why shouldn't they stay there?

Yet its fashionable to scoff at Treasury rates, even now that yields have backed up. Some fear inflation, due to the massive stimuli currently being thrown at the economy. But with financial institutions as well as households rapidly deleveraging, there simply isn't enough spending to create inflation right now. Some day I hope inflation becomes a problem, but we're a good ways off from that. Consider that, according to Merrill Lynch economist David Rosenberg, that the balance sheet of U.S. households has declined by $13 trillion. The expansion of the Fed and the Treasury's balance sheet has been only 1/5 that amount.

Others fear supply of Treasury bonds. But the reality is that savings rates world wide are set to increase, creating more demand for safe assets, not less. We don't need to worry about Treasury borrowing crowding out private sector lending. Not now at least.

Finally, the Fed has a strong interest in keeping Treasury rates low. There won't be any economic recovery if mortgage rates start rising. The Fed won't be able to maintain a mortgage rate south of 4.5% if the 10-year Treasury rises above 3%.

And here is a little secret: The securitized mortgage market is about double the size of the Treasury market. It will be much easier for the Fed to manipulate Treasury rates lower than to manipulate mortgage rates!

Income-conscious investors may be loathe to buy up long-term Treasuries at current yields. Those investors should consider any very high-quality non-callable bonds: government agencies, municipals, and some corporate bonds would all make sense.


Positive Gamma said...

I like the theory but I recently became enamoured with TBTs and trade them quite frequently. I wonder how many are like me once adjusted for the increase in daily volume

Unknown said...

I wondered if you would consider revisting your post of September 10, 2007 given subsequent market events. If you recall, your September 10 post "What's in the bear's cave? Only what you take with you" critiqued those who were anticipating a "major recession/massive market repricing to correct a (perceived) deep imbalance" in the markets and seemed to discount the view held by some at the time that "the financial markets always seem like a house of cards". I would take pains to emphasize that you didn't rule out any possibility in your post and that many, many of your theses on this blog have subsequently proven to be right. At the same time, revisiting past theses, whether they ultimately prove right or wrong, I think can be a useful learning tool, and I would be interested to know if you remained fully invested through the credit meltdown as you did during the tech meltdown earlier this year, as well as any other thoughts you might have on the old post--I think it would make a great reflective post if you have the time. Thanks as always for one of the most insightful and intelligent blogs I read on the web.

Keith said...

Volume like that is often a sure sign of a bubble, you are right, but don't forget: The volume of TBT is nothing compared to the volume of the treasuries themselves. I'm sure rapidly changing volumes could result in challenges for Pro Shares to keep their ETF on track with their goal of 2x inverse performance of TLT, but practically no amount of volume can really budge the underlying treasury market, compared to what money market funds and foreign banks decide to do.

On that note, you have rising volumes of treasury issuance, decreased trade deficits with may reduce foreign investment, the inflation question, and historically low yields. While I'm sure TBT will have its ups and downs I think it crazy to call it a bubble, especially when a year ago it was 69 and today it is 46.

I do have a personal position in TBT.

Sean said...

One other point you didn't mention which a colleague of mine mentions frequently is a very simple one: How can a security be in a bubble if *everyone* hates it!

Quite simply, when internet stocks were in their bubble phase any old stock was rocking and rolling, analysts were swooning, and their was universal love for the asset class. When housing was forming its bubble phase, same thing: Stories in the popular press about how housing never went down nation-wide, housing was a great investment, and on and on. Oil Prices - Peak oil, insatiable demand, higher and higher price targets.

Treasuries have never had such love. They get derided at every opportunity about how much of a sucker-play they are. The fact that they are so unpopular is a clear sign that they are NOT a bubble and could be a decent intermediate term investment.

Just my 2c, and no, i don't have a position...

Accrued Interest said...


Heh... sounds pretty wrong now eh? The spirit of my piece was this: Every problem is solvable, capitalism works, and the business cycle will always turn.

Within that framework, I think you can be as bearish or as bullish as you want to be. But to take a certain position permanently is foolish. In other words, to always be bearish is dumb.

Now obviously this thing has turned much worse than I expected. But I still see most businesses thriving again some day. And that day isn't years and years away either.

The biggest change in my thinking is that going forward, businesses need to fundamentally change how they finance themselves. Prior to Lehman/AIG, I thought we'd eventually get back to a financial system that was basically the same. Less levered, sure, but not structurally different. Call it a return to 2002. Now it's going to be a full on restructuring.

As far as me remaining fully invested... yes but truthfully with varying degrees of hedge. I was usually net short stocks in 2008. I went neutral just the other day for the first time in months. I blew it on a couple long oil trades among others, but managed to make money personally in 2008.

Accrued Interest said...


I was just trying to contrast those that are calling Tsy's a bubble, when in fact the short Tsy ETF looks more frothy.

Sean you are 100% right.

In Debt We Trust said...

AI, how do you contend w/the rise of gold then?

Keith said...

I know it means nothing, but I still can't help but be amused that TBT went up 4.25% today.

Unknown said...

please correct me if my math is off:

63 million TBTs * $47 = about $3 billion.

Our national debt = @10 trillion.

Numbers like that imply that TBT is the effect, not the cause.

We are in the middle of the greatest monetary stimulus in history. I suspect that carries with it some threat of inflation if the economy can be restarted and credit markets are revived.

John (Ad Orientem) said...

Just my two cents, but I think gold's rise can be attributed to several factors. First would be the normal attraction which it has among investors during times of economic uncertainty or crises. Secondly, many people (including me) believe that long term a spike in inflation is inevitable with this kind of debt and massive printing of money. And third despite what many people see as historically high prices for it, gold is in fact trading at less than half its high from early 1980 when you adjust for inflation. Gold has significant potential upside to it and even in a deflationary environment its downsides are limited.

Just as as a disclaimer, I am NOT a gold bug. In fact I generally don't look at gold as a particularly good long term investment if you define "investment" as something which you expect to accrue in value over time. But I do like it as the financial equivalent to fire insurance. I think in normal times everyone should have maybe 5% of their portfolio in gold and in the present circumstances I am leaning more towards 10%.

Unknown said...

Thanks AI, as always, for your thoughts and for calling 'em the way you see 'em.

Lockstep said...

Great post. Lots to think about. I am expecting to make money long or neutral on TLT, so observing the premium in the more volatile derivative of the index gives me ideas for more profitable positions.

Unknown said...

How big is the treasury market and is this information published on a regular basis? I've been hearing the mortgage market is around 10-15 trillion... but does this include HELOCs and other HE products? I am guessing it does not, so do we know the general size of that as well? Thanks.

Unknown said...

Derek says: "We are in the middle of the greatest monetary stimulus in history. I suspect that carries with it some threat of inflation if the economy can be restarted and credit markets are revived."

Yes, but we are also in the middle of the greatest destruction of wealth in the shadow banking system, so use caution when thinking that some stimulative policy actions executed by the fed/treasury will directly fall to the ground and cause inflation. This is debt deflation, and time/deleveraging/default/restructuring is what we need and time is the cure for that. I just hope the gov't/fed allow this process to play out.

Unknown said...

"AI, how do you contend w/the rise of gold then?"

All major fiat currencies are being debased to deal with severe local recessions. Confidence in fiat currencies and the amount of government meddling is in my opinion what will make the gold trade for the next year or two. I do not see it as an inflation trade, and I have argued on urbandigs since early 2008 that a debt deflation is what we are experiencing now; a major contraction in credit and destruction of a leverage fueled asset boom

wagner2626 said...

I am sure that all of you know, but be very careful with TBT and other leveraged ETF's. These are good for short-term traders and should not be held for any extended amount of time.

Here is why: the ETF is designed to provide negative 200% of the daily move in the underlying index. Let us say that the index is at 100 and the ETF is at 50. If the index drops 10% to 90, the ETF should go up by 20% so it would move to 60. So far so good. Now the index goes back to 100 - which is an 11% move. So the ETF now drops 22% or to 46.80. So the index is flat, but the ETF has suffered a 6.40% loss.

If the index goes in one direction, the ETF can outperform. Say that the index goes from 100 to 90 to 80. If you has been short the index you would have a 20% gain. The ETF will go from 50 to 60 to 73.3 a 46.7% gain or more then double the 20% gain just being short would have provided.

AI - Maybe you can provide a graph of SRS which is a double short ETF on the DJ real estate index. The index had a horrible year in 2008, dropping 43.4%. If you had SRS you were short 2x so a gain of close to 90%, right? Nope. SRS DROPPED over 50%.

Finally if this does not scare you, levered ETF's can have unwanted tax consiquences. Let us say that the fund is successful. But some people want to get out. You think that the trade still has room to run. As others leave, the fund must sell its futures or swap positions. This will generate gains that apply to all fund holders.

Finally a word on AI's position that 1)the savings rate will increase and soak up the supply of treasuries and that 2)the Fed wants to lower treasuries to get mortgage rates lower.

I do not believe that households will buy treasuries. They will work to lower their debt payments. Why buy the 10-yr at sub 3% (about 2% on an after tax basis), when you can pay down a mortgage. If that payment then goes to reduce leverage at the holder, be it a bank or CDO, then those funds are taken out of the economic system. Two, I think that the Fed buying Treasuries with high mortgage rates is a fool's errand. It is not low Treasury rates that stimulate the economy, it is low accessable interest rates. In the past people have used Treasuries as a proxy for all these other rates. Jumbo mortgage rates have moved basically one direction in the last 3 years, while Treasury rates have fallen. In fact, jumbo yields had a peak about the same time that 30-year treasuries hit all-time lows. The Fed's goal is to spur the economy, that is why they are buying mortgages, financing other recievables and have not bought any long-term Treasuries to date.

Accrued Interest said...

Thanks for all the great comments. Amazingly civil compared to the rest of the blogosphere.

Anyway, didn't mean to imply that TBT per se is causing Tsy rates to rise. More that the parabolic rise in TBT ownership is a sign of how popular the short Tsy trade is.

As to the savings rate... its all inter-related. Households don't have to buy Tsy directly. Increased savings causes a decrease in the demand for money system-wide, pushing all interest rates lower. Right? The other side of that coin is that there is more capacity for lending, including to the Federal government.

As for gold, the problem is that gold only has value due to speculation. It isn't like other metals where the price is driven by industrial use. Now if we saw a co-ordinated rise in commodities, that's potentially inflationary. But we aren't.

Jakedeez said...

Most leveraged ETFs are a good short. The long side products bleed out from high vol, and the inverse products always come back down from the pops... Almost always a good bet to short.

If you want to short treasuries, which always seems like a bad idea to me; just buy a call. If you have an ISDA then buy a swapotion.

And if what you really want to do is short the USD... short the USD. To me it has never made sense to short tsy because you just don't have the firepower to sustain the trade... no one does.

GlobalMacroSpeculator said...

the truth is governments are too incompentent to the us out of this mess

In Debt We Trust said...

Not all of us have access to institutional instruments like swapoptions. Besides shorting TLT or buying TBT there's not many choices to be a bond vigilante.

Btw, AI you have to clean up that wow gold poster.

Jakedeez said...

There is a world of difference between shorting bonds and playing a swap product like TBT.

It is important to note however that you can not effect the price of bonds with the TBT, I mean, maybe if you spent $500,000 in the spread you might move the long bond a tick, but you would kill yourself pushing. You can't fight someone with a printing machine.

I know how attractive the idea of the TBT is, but you have to realize that the leverage is distorted over time. And if you think the long bond is frothy, far better to short the EDV imo.

Accrued Interest said...

Yeah this wowgold asshole is pissing me off.

PNL4LYFE said...

I think there are two seperate issues regarding the ETFs. ETFs are much more accessible to most investors than other rate products. However there is a well known problem with levered/ultra ETFs underperforming their benchmarks, sometimes dramatically. For that reason, short TLT is a better long term trade than long TBT.

In Debt We Trust said...

PNL4LYFE, I prefer shorting TLT (through puts) b/c of the constant leverage decay associated w/ETFs and rebalancing issues.

It's a small but important thing in the trade's favor.

Jake, I realize that holding an ETF will have little to no effect on the underlying issue. It's like buying thousands of SKF shares and trying to move financial stocks lower. SKF does not actually short the financial stocks but rely on swap trades instead.

mannfm11 said...

Really on track Accrued. I am trying to form some kind of view on what is going on here and something tells me the actions to counteract are deflationary, despite their intent. The Fed acquires the assets out of the system. They have also moved interest rates so low that anyone who has debt and cash too has to think of paying off the debt, thus destroying more money in the process. Savings is reflected as debt, which is why Japan deflated. Countries and economies don't deflate unless their level of debt has reached a point that it can support sizable amounts of cash balances to create asset bubbles in the first place. One of the great paradoxes of modern finance.

Unknown said...

AI you said "Gold isn't like other metals where the price is driven by industrial use"

That is exactly why I like it when the world faces deflation, and we see the tail end of overcapcity - overinvestment - overleverage.

Gold, in my view, is an alternative form of money, at a time when every CB is printing and there is a loss of faith in fiat money. Explains why it outperforms copper.


Mashuri said...

Noah has it right. Gold doesn't hold value because of speculation. Gold holds value because it has no counterparty risk (unlike anything fiat denominated), it's supply is quite stable and it DOESN'T have any industrial use. It's the most stable currency in existence.

Anonymous said...

Thanks u r information

stock market trading said...

The Country is experiencing recession so expect a decline of price of treasury bonds. If this will still happen traders will be able to manipulate Treasury rates lower than to manipulate mortgage rates.