4.10.14: The Punishing and Unrelenting Bid in the Treasury Market

Last Friday morning, April 4th, 2014, when I saw the 194,000 and then the 32,000 upward revisions in the payroll number, I thought, “This number might get Treasuries to back up a little” which was absolutely the wrong thought by the end of the day.

This week, particularly on Wednesday, when I saw the equity indices bounce after the Fed minutes I thought “We could see some selling in Treasuries, finally”, which was not correct.

This morning when I saw and heard the 300,000 and the sharp drop to get to that number from Rick Santelli at the CME, I thought “Finally, might get this Treasury bid to relent some”, which as of 2:35 pm on Thursday afternoon is the exact wrong thought.

When the 10-year Treasury finished 2013 at 3.03% on 12.31.13, I thought, “2014 should be another tough year for Treasuries, maybe as bad 2009” when in fact so far this year, the 10-year Treasury was up 6% in q1 ’14 and is up again since the start of the quarter despite the stronger economic data.

This has been our worst trade all year, and here are some possible reasons:

1.) Not only does inflation remain subdued, disinflation continues. It seemed like the Fed was starting to worry about “accelerating wage inflation” until Friday’s March ’14 jobs report showed average hourly earnings fell to 0%, from February’s +0.2%. So much for the inflation worry;

2.) Talk of deflation in Europe is rampant but it could simply be a function of a Financial Media in Europe being far worse than what we have here in the US. Supposedly the Spanish 10-year Sovereign paper is now yielding less than Treasuries, which could be bringing other buyers that were European yield-oriented into US Treasuries;

3.) Treasuries are valued over the long-term in “real-return” perspectives: a 2% inflation rate should result in a 4% 10-year Treasury yield to allow the holder of debt the long-run real return of Treasuries of 2%. At 2.60%, the 10-year Treasury is telling us that the “real” inflation rate could be between 0.5% and 1%.

4.) The Fed’s favorite inflation indicator, the PCE deflator, was – the last I heard – near 1.2%, although I’m too lazy to look.

Nuveen’s muni high yield fund available from Schwab (NHMAX) is yielding 6.11% and that is a tax-exempt yield. The HYG is yield 5.93% and is down a whopping 0.20% despite the crushing of stocks, which tells me the credit market is taking equity market in stride.

Waiting on a bear market in Treasuries has been like Waiting on Godot. Part of the reason could be that there has been so many similarly positioned as Trinity has been with little duration risk, lots of short-term paper, and scared of a back up in rates. Seriously, if you go back to 2003, and the early days of the start of Gulf War II, Rick Santelli would give the JP Morgan portfolio manager survey every Tuesday morning, and there would consistently be a 90% – 93% bearish sentiment reading on Treasuries, meaning 90% – 93% of managers would be short their duration benchmark.

The crowd has been wrong again, and we’ve been a part of the trade.

Very frustrating, and ugly, The TBF Inverse Treasury has been our worst trade year-to-date. We sold our small-cap’s, and Goldman Sachs, and some other “hot” stocks and sectors, but managed to tinkle into the wind with a 10% – 15% Treasury short.

Just had to vent. This too shall pass.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager




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