The Bubble in TBT Fund

Just a few weeks ago, a number of commentators were calling the Treasury bond market a bubble. The 10-year Treasury had fallen to nearly 2.00%, and the 30-year bond had fallen to 2.50%. But since that time, the 30-year Treasury has risen by 100bps, representing a 19% decline in price.

Now if you really want to find a bubble, try TBT, the ProShares UltraShort 20+ Treasury ETF. This fund is designed to delivery -200% of the return of the 20-year and longer segment of the U.S. Treasury market.

First take a look at the shares outstanding in TBT. This is an excellent proxy for how popular a short US Treasury trade has become.

What’s one of the conditions for a bubble? Parabolic increases in demand? The outstanding shares in this ETF has gone from about 7 million shares on 10/31 to nearly 63 million shares now.

Treasury bonds should be hitting new lows in yield. Economic and liquidity conditions are as bad as its been since the Depression. Deflation is a more serious threat than its been since that same time. Why shouldn’t interest rates fall to record lows? Why shouldn’t they stay there?

Yet its fashionable to scoff at Treasury rates, even now that yields have backed up. Some fear inflation, due to the massive stimuli currently being thrown at the economy. But with financial institutions as well as households rapidly deleveraging, there simply isn’t enough spending to create inflation right now. Some day I hope inflation becomes a problem, but we’re a good ways off from that. Consider that, according to Merrill Lynch economist David Rosenberg, that the balance sheet of U.S. households has declined by $13 trillion. The expansion of the Fed and the Treasury’s balance sheet has been only 1/5 that amount.

Others fear supply of Treasury bonds. But the reality is that savings rates world wide are set to increase, creating more demand for safe assets, not less. We don’t need to worry about Treasury borrowing crowding out private sector lending. Not now at least.

Finally, the Fed has a strong interest in keeping Treasury rates low. There won’t be any economic recovery if mortgage rates start rising. The Fed won’t be able to maintain a mortgage rate south of 4.5% if the 10-year Treasury rises above 3%.

And here is a little secret: The securitized mortgage market is about double the size of the Treasury market. It will be much easier for the Fed to manipulate Treasury rates lower than to manipulate mortgage rates!

Income-conscious investors may be loathe to buy up long-term Treasuries at current yields. Those investors should consider any very high-quality non-callable bonds: government agencies, municipals, and some corporate bonds would all make sense.

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