The Great Treasury Bubble, Or Something Worse….

There has been one asset class which has held up with flying colors: US TREASURIES.  It has been a great ride if you hold them, but the yields are reaching a point that signals something disastrous.  The sad part is that this is not just a warning or just temporary funds seeking "just in case" havens.  It is signaling another major shoe to drop imminently.

We all know the story.  A global recession (and officiallynow too) is in force.  Manufacturing has fallen off a cliff.  China andIndia are slowing even faster than their "growth numbers" are probably telling us.  The value of assets is being repriced from top tobottom.  Deflation has rapidly replaced inflation.  The globalinfrastructure trade is dead.  Stimulus packages are no better thanbandages for chemo patients.  Housing is bust.  Credit is dying on thevine.  Capital markets have been shut off. 

But honestly, bonds are pricing in another major shoe dropping with thetime table being "imminent."  Is this the "real" failure of a majorbanking or financial institution from the "too big to fail" club?  Isit one of the Big-Three (or all of them) declaring bankruptcy?  Is itthe implosion of states and municipalities?  Are nations going to start defaulting on their sovereign debt?

Gold has not even acted as a safe haven lately.  It seems that precious metalsaren’t so precious and certainly are no longer needed by central banksthat own printing presses.  The economic data is also not going to getany better in the immediate future and it might take quite a few cyclesbefore it starts to level off.  We are already seeing bond funds and corporations halt dividend payments.

In the short-term, investors are willing to take no yield at all justso that the money is not at risk.  But even in the long-term the same thingis becoming apparent.  These yields are essentially the lowest acrossthe board than they have ever been.  To have the 10-year T-Note under4% has been extreme, but now it is under 3%.  And now the 30-year isonly one more "flight to quality day" away from hitting 3%.  Most of us have never seen yields get this low… Ever.  Look at how low the yields are below.

Mature Yesterday  Last Wk  Last Mo.
3-Month   0.03%      0.01%     0.37%
6-Month   0.43%      0.43%    0.81%
12-Month 0.79%      0.90%    1.01%
2-Year    0.89%      1.20%     1.54%
3-Year    1.11%      1.50%     1.26%
5-Year    1.69%      2.20%    2.80%
10-Year  2.69%      3.32%     3.95%
30-Year  3.20%      3.78%     4.36%

Ben Bernanke just signaled that there are likely more rate cuts tocome.  Maybe we have to become a zero-rate economy like Japan.Its 10-year note yields only 1.36% and even the Hong Kong note yield is1.8%.  Fed Funds are now down to 1.00% in the U.S. and Prime sits at4.00%.  The elusive LIBOR was at 1.91%.  For the FOMC to cut rates ifthe current yield curve became static, it looks as though the FOMCwould have to take down the Fed Funds rate to 0.50% from 0.625% at the next meeting and as though they would have to keep an "easing bias" as a certainty rather than a hint.

Ben Bernanke also said that this is nothing at all like the 1930’s.  Hemight be right.  This may just be the 1929 part of the equation.

What else is there to say?  This is becoming the sick joke of the day,but the joke is in such bad taste that the punchline is becoming taboo.

This is no longer a flight to quality.  It is an exodus away from allasset classes, followed by a musical chairs version of quality.  If there is not another major shoe that drops in the coming days, yields of US Treasury maturities will bounce and will bounce big.

Jon C. Ogg
December 2, 2008