Has the U.S. Treasury Implosion Begun?

I’ve been consistently warning that U.S. government bonds will eventually implode. Using history as a guide, I know that when the sell-off in bonds begins, it will be very swift. The magnitude of panics are inversely correlated to the degree in which investors are deluded. Some of the most ignorant comments I’ve ever heard have been on the bearish side for gold; hence panic buying in gold should be pretty substantial. As for bonds, take a look at the dramatic spike in 10-year treasury yields since Helicopter Ben decided to embark on QE2. As I’ve been saying, deflationists just don’t get it. In my opinion, it is likely that the early stages of the bond bubble collapse have begun.

Although U.S. government bonds are a disaster waiting to happen, it would be irresponsible of me to not give you some perspective here. Yields have spiked nearly 50% in about a month. To put it plainly, it is not necessarily the best time to open up short positions on bonds. If I had no position whatsoever, I would wait for some kind of partial retracement to go short. In fact, if I absolutely had to take a stance, I would probably favor going long bonds now. However, all bets are off if we spike above 4% on the 10-year. This will be the market’s message that the debt crisis is spiraling out of control; it would be the equivalent of gold breaking out above $1030 last year, never to look back again.

The recent sell-off in bonds has been sharp and swift, as I always warned it would be. I’ve been trying to explain that the buyers of bonds are speculators barely distinguishable from the speculators who brought the housing bubble to a crescendo. These investors are attempting to front run the Fed. Believe me, these are not “hold to maturity” investors. So many people make the argument that as long as investors hold to maturity, U.S.  bonds will do just fine. Assumptions like these are what blow up models time and time again. Garbage in, garbage out. Capital seeks preservation. Foreign holders of our debt will have no qualms about selling our debt and loading up on the short end of the curve. This totally changes the dynamic of our debt crisis, making Ponzi scheme financing that much more difficult.

If you have a $14 trillion economy and, let’s say, $500 billion in debt, a 50% spike in yields is manageable. But let’s say you have a $14 trillion economy and $14 trillion in debt. At this point, the increase in debt servicing costs is equivalent to the entire budget deficit of previous years. Wake up and smell the roses folks, debt operates geometrically.

Capital is taking on a “wait and see” approach as most markets correct. This makes sense because many markets, including stocks and commodities, were in overbought territory. Markets are still trying to find some footing here, so it would be wise to take smaller positions until further notice. The short U.S. government bond trade will eventually be one that the biggest investors in the world will take in size. We are not there yet, but eventually we will see some epic moves in bonds. Make no mistake about it: gold will be the prime beneficiary of such a move.

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  • Scott

    Until the bond rate goes beyond it’s long term average (I like to use the average over 20 years, 5.33 currently, as it encompasses at least two boom and bust cycles), I wouldn’t be getting too excited.

    • http://www.expectedreturnsblog.com Moses

      Your 20-year average calculates rates when they were in a secular bull. Even the biggest treasury bulls must admit that it is about time for the cycle to reverse.

      CS P/es are at about 22-23, correct, but they lag the market a bit. The 10-year period of CS calculations includes bubble-like valuations in stocks.

  • Johnm800

    Is TBT the best play on treasury bond implosion?

    • http://www.expectedreturnsblog.com Moses

      For small investors yes. Gold and silver are other options.

      CS P/es are at about 22-23, correct, but they lag the market a bit. The 10-year period of CS calculations includes bubble-like valuations in stocks.

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