Longer Maturity Bonds Coming? What Does It Mean For Investors?

ZeroHedge reported a few days ago that Trump’s pick for Treasury Secretary suggested in an interview with CNBC that he’d be open to issuing new bonds of longer term maturity:

“I think interest rates are going to stay relatively low for the next couple of years.” Mnuchin told CNBC. “We’ll look at potentially extending the maturity of the debt, because eventually we are going to have higher interest rates, and that’s something that this country is going to need to deal with.” Ironically, with that statement, Mnuchin quickly sent yields spiking higher, although courtesy of foreign buyers these were promptly renormalized.

Treasury Rate Spike

The mini selloff in Treasury securities on that day could have been prompted in part by anticipation: When longer bond options become available a certain portion of long bond investors while invariably sell off a portion of their current holdings to reach for the higher yield.

For example, investment strategies such as the permanent portfolio (which I follow) require you to allocate 25% to the safest & longest government bonds denominated in your local currency.

On the net such a move would simply be a gift to such long bond investors, since longer maturities offer more upwards punch precisely when needed, that is when deflationary pressures prevail and interest rates plummet. Furthermore longer maturities pay higher interest rates, essentially a risk free subsidy to those with money to invest in this manner.

If you’ve read my post about Modern Money Theory you’ll understand that most other reasons cited by Mnuchin don’t make much economic sense, since the government doesn’t really “need” to borrow money or issue long term debt at all:

Why sell longer term government bonds like the Treasury does, effectively setting a risk free rate and thus a floor for longer term loans? Again a good question! In fact, MMT ultimately suggests that beyond very short term Treasury Bills at most there’s really no reason for the government to be floating long term bonds.

Within the confines of today’s fiat money system, MMT actually offers the most libertarian alternatives regarding interest rate management and government bonds: let the overnight rate go wherever market conditions amongst private banks let it go, and don’t issue any long term government debt at all!

And in Why The National Debt Doesn’t Matter I explained:

When the Treasury pays interest on the public debt, it does so by asking the Fed (the banks’ bank) to mark up the recipient’s bank’s bank reserves via electronic keystrokes. It doesn’t need to raise taxes anywhere in order to perform this operation.

On that same token, when the Treasury retires a maturing government bond, it asks the Fed to remove said bond from the bondholder’s bank’s securities account and in turn marks up said bank’s bank reserve account accordingly. Once again, no tax money is needed to perform this operation. No future generations, to cite a popular cliche, are being asked to cough up the money to perform this operation.

And on Mnuchin’s claim that we’re “going to have higher interest rates, and that’s something that this country is going to need to deal with”, I’ve pointed out the following in that same article:

How many bonds are outstanding, at what maturity, and how much interest we wish to pay on them, are both 100% present-day political decisions that the federal government can make independently of the private sector. Theoretically, all outstanding bonds could be replaced by bank reserves that pay zero interest. All that would happen, in that case, is that one type of government obligation (government bonds, the promise to pay future bank reserves) is replaced with another government obligation (bank reserves, the promise to accept them to settle tax liabilities).

In other words: In a sovereign floating fiat money system rates on government bonds are always under the government’s control, letting them float is a choice, not an imperative.

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PIMCO Admits: Betting Against Treasurys Was a Mistake

I have been consistently bullish on US Treasurys.

PIMCO now says that betting against US debt was a mistake:

Showing a more bearish view on the U.S. economy, Gross said PIMCO had initially dumped all of its U.S. debt holdings in March as he expected economic growth to be higher, resulting in inflation down the road.

That decision greatly undermined the performance of PIMCO’s Total Return Fund. As Treasuries prices rallied, the fund lost 0.97 percent in the past four weeks, while the benchmark Barclay’s U.S. Aggregated Bond Index rose 0.23 percent in the same period, according to Lipper data.

So far this year, the fund has returned 3.29 percent, less than the 4.55 percent recorded by the Barclay’s benchmark index.

“When you’re underperforming the index, you go home at night and cry in your beer,” the Financial Times, in its online edition, quoted Gross as saying. “It’s not fun, but who said this business should be fun. We’re too well paid to hang our heads and say boo hoo.”

Gross, who oversees $1.2 trillion at PIMCO, said it was “pretty obvious” he wishes he had more Treasuries in his portfolio right now.

Like I’ve said many times before, I think Treasury yields will stay low for much longer than people expect. Global flight to safety, over indebtedness, credit deflation or rather outright deflation, recessions, depressions … all these are bullish for cash and near-cash assets (of the world’s reserve currency), such as Treasury Bonds/Notes/Bills, and of course the mother of all cash … gold.

PIMCOs announcement above may be a nice contrarian indicator to get out of Treasurys for a little while … but then why would you want to daytrade such an investment … relax :)

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Long Term Treasury Securities – Foreign Demand Rises

As deflation continues to run its course, debt destruction goes on, and people seek save haven investments Foreign demand for long-term US securities rises:

Foreign demand for long-term U.S. financial assets rebounded in June even though China and Russia trimmed their holdings.

The Treasury Department said Monday that foreigners purchased $90.7 billion more in long-term U.S. securities than they sold in June. That’s a significant rebound from May when they sold $19.4 billion more than they purchased.

“There is little evidence in recent (Treasury) reports to suggest that foreign investors are growing weary of buying U.S. securities,” Jay Bryson, a global economist at Wells Fargo Securities, wrote in a note to clients. The increased appetite for Treasury securities was partly because their yields rose in early June, he added.

The Treasury is auctioning record amounts of debt to cover what it estimates will be a $1.85 trillion budget deficit this year. If overseas buyers don’t continue purchasing U.S. debt, some economists worry that would mean falling demand at Treasury debt auctions and rising interest rates.

China, the largest foreign holder of U.S. Treasury securities, trimmed its holdings, to $776.4 billion in June from $801.5 billion in May. Russia also reduced its holdings 3.7 percent to $119.9 billion in June.

China’s holdings are a direct result of the huge trade deficits the U.S. runs with the emerging Asian power. The Chinese take the dollars Americans pay for Chinese products and invest them in Treasury securities.

[smartads]American manufacturers argue that gives China unfair trade advantages by keeping the dollar overvalued against the Chinese currency, which makes U.S. goods more expensive for Chinese consumers and Chinese products cheaper here.

Both the Bush and Obama administrations have argued that China should allow its currency to rise faster in value against the dollar, but the yuan has stopped appreciating against the dollar in recent months.

Japan, the second largest holder of U.S. Treasury securities, increased its holdings 5.1 percent to $711.8 billion in June. And the United Kingdom, the third largest holder of Treasuries, increased its holdings nearly 31 percent to $214 billion.

Foreign governments purchased $22.5 billion of Treasury bonds and notes, the department said, after selling $21.8 billion in May. Overseas governments sold $5.9 billion in bonds issued by mortgage giants Fannie Mae, Freddie Mac and other government agencies.

Private foreign investors purchased $78 billion in Treasury bonds and notes in June, the department said, up from sales of $800 million in May.

Today yields on ten year notes are currently at 3.49 percent. I am still as bullish as I have been before on Treasury Notes and Bonds:

Back in November 08 I called for significantly lower Treasury Yields between 2% amd 2.5%. They then fell from 3.09% to just below 2.5% in January 09. I then expected for technical reasons that they will move higher to the upper end of the range which would be around 3.3%. They actually overshot and went as high as 3.99%. I then said that Treasurys are a good call again. Yields have since then fallen to around 3.30%:

10-year-treasury-2009-july-10

Click on image to enlarge.

I think Treasurys will continue to act well. There maybe some upward pushes here and there so long as inflation expectations pop up once in a while, but the mid-term trend remains unchanged: It is likely that yields are headed for new lows.

Just recently someone commented as a response to my post on consumer prices:

Bullish long term treasuries?

If so, I think your arguments should directly go to the trash.

Even though private lending is not increasing, it is currently being replaced by government debt or money. Yes stocks are risky, but the dollar is even riskier.

Maybe I am wrong and there is a flaw in my thinking. If so, then nobody has successfully pointed it out yet. Statements like the above reflect the commonly spread notions of the public who does not like to bother with details and easily falls for simple platitudes. This just reaffirms my beliefs. But we shall let reality be the final arbiter. I believe that Treasury yields are headed lower for the remainder of this year.

As far as my thoughts on the Yuan:

In 2005 the Chinese government ended the peg against the US dollar and switched over to a currency basket. From 2005 though June 2008, the value of one Dollar dropped from RMB 8.28 in 2005 to about RMB 6.83 by June 2008.

Since then, it seems, the fall of the dollar has stopped and the Yuan/Dollar exchange rate remained suspiciously stable. This has gone on through right now. The chart below illustrates this:

The stabilization of the Dollar against the Yuan has almost coincided the reversal of the Dollar’s fall against other major currencies. It thus appears as if, since mid 2008, the Yuan/Dollar peg has been reinstated and continues to be in place as these lines are written. What is also noteworthy is that the US current account deficit has been declining sharply since then.

A first look at the above chart leads one to believe that Chinese and US authorities aimed at putting an end to the fall of the Dollar, and thus intervened accordingly. However, another possibility which I would like to propose is that the Dollar had fundamentally and truly begun to stabilize at the level of RMB 6.83 at that point and was actually in for a major revaluation upwards. Thus the current intervention by Chinese authorities could actually be aiming at a stabilization of its own currency at a higher level than the market would mandate.

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