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Commentary

Shorting treasuries looks attractive

8 May 2015 by Jim Fickett.

As you have most likely heard, Buffett recently said in a CNBC interview.

If I had an easy way, and a non-risk way, of shorting a whole lot of 20- or 30-year bonds, I’d do it. But that’s not my game, and it can’t be done in the kind of quantity that would make sense for us. But I think that bonds are very overvalued, I’ll put it that way.

So one must ask (yet once more), is there evidence that we might be near the bottom in long-term bond yields? The answer is yes. Here is the history of the 10-year treasury rate and core inflation for the last 60 years:

Note first that yields are, in absolute terms, at a 60-year low.

Second, note that 10-year treasury yields rarely fall below the core inflation rate. But recently they have done so.

And third, note that US inflation is unusually low. The average inflation rate over the last 102 years is 3.0%. Currently the core rate is below 2%.

So inflation is likely to rise, and yields are likely to rise above inflation.

If one could just buy and hold yield, rather than shorting treasuries, there would be no question. Yield is too low, and treasuries too expensive. But of course real-life shorting requires good timing.

You might get the idea from Buffett's statement that he is making a statement about timing, saying that whereas before it was too early to short treasuries, now is the time. In fact, if you listen to the quote in context, it is clear that he is making no such statement. He is very clear about the timing risk, saying in particular that Europe may need to hold rates low for longer and, if they do so, it will be difficult for the Fed to raise US rates very much.

On the whole I think a short position in the fairly near future might make good sense. Yes, it is true, European policy might delay Fed action. On the other hand, the Fed's own economic criteria for action (e.g. the unemployment rate) will push for some action before much longer; various Fed members in various fora have more or less admitted bubbles are a present danger; and the general sentiment in the bond market is clearly more negative than it was.

For a previous attempt to quantify the risk of using ETF shorting funds in this context, see Short on Treasuries and Inverse ETFs and Treasury yields.