Treasury Bond Yields: Gloom, Doom or Collapse? (Or All Three?)

It is with complete awe - and yet with complete and shuddering horrification - that myself and a few colleagues watch as the price of 10/30yr. Treasury bonds climbs inexorably higher into the stratosphere; and conversely, the yield across the entire Treasury curve grinds toward zero.  Of course, there has been heated debate about the implied message of the market.  Deflation?  Recession? Insanity?  Here's chart of the 30-yr. Treasury bond (aka "the big daddy") to get your mind spinning:

(click on chart to enlarge)

The last time the market chased Treasury bonds like this was December 2008.  Recall that this was a period when the banking system seized up in insolvency and was subsequently bailed out with a couple trillion dollars of printed money, taxpayer money and taxpayer guarantees (I would argue, probably successfully, that the banking system indeed suffered a de facto collapse).  It also preceeded a near-collapse in the Dow/S&P 500. 

To be sure, I can understand why hoards of money might flood into the short end of the yield curve, driving yields in 30/60-day T-Bills negative.  And we did experience negative yields on the short end of the curve during 2008.  The reason an investor might accept a negative return on a T-bill is because the return of that money is guaranteed by the Government's ability to print money in order to make good on the security.  Conrast this with keeping your money in a demand deposit account at a bank, there is chance, albeit slight, that you might have to wait to get that money (a bank holiday scenario) or you don't get it at all (your bank goes under and your checking account exceeds the amount of FDIC coverage). 

In effect, buying a T-bill on a negative yield means that an investor is willing to PAY for the safety of knowing that he will actually get his money back.  I know this sound crazy, but if you have a large sum of money and lack the foresight to buy and hold gold and silver, the only guarantee of getting your money back in a collapsing system is ability of the Government to print that money and distribute it to Treasury bond investors.  This works even when Tim Geithner helps the big banks loot the Treasury of cash.

My best guess with regard to the message of today's bond market - and I say this in the context that for sure a lot of the Fed's QE cash is flowing heavily into the bond market (yesterday's post) - is that we (the U.S./Europe) are headed toward another credit crisis of some sort - or maybe of all sorts.

The housing market is beginning to plummet, foreclosures are hitting new highs after a slight hiatus during the first quarter of the year - which will begin to weigh heavily again on banks - deficits have become catastrophic in several large States and the commercial real estate credit problem is going to start accelerating as the economy heads quickly south again.  While ALL of the above credit-related problems were never properly addressed/fixed (they were papered over temporarily), the credit crisis in commercial real estate has been completely swept under the rug, with banks carrying a hefty portion of their commercial loans - and of course the associated derivatives postions - at or near full value.  A good friend of who is in the credit restructuring consulting business told me that there is very little restructuring work going on right now because the banks refuse to take the pain as long as the Fed is keeping them liquid.  This is especially true in the area of commercial real estate loans.  In fact, you can blame the next credit catastrophe that hits on the complete failure of leaders in both Government and business to address and remedy the true underlying systemic problems.

The point here is that I would suggest that the price/yield action in the Treasury bond market largely reflects the expectations that a credit crisis is brewing once again.  One possible indicator to watch will be yields in the high yield bond market. I like to use this link to monitor that:  High Bond Yields.  Back in 2008, yields on this junk bond index spiked over 20% several months before capital flooded into the Treasury bond market. 

Also watch gold.  Gold is going to continue its inexorable bull market until the system is completely cleansed and rebuilt from ground zero.  Any number of painful events will force this to happen.  I'll leave that you to do some historical research on what types of events, but the "w" word is always one of them.  Right now gold is nearly 25% higher in price than it was in March 2009, which was when the Dow went below 6700.  That is a message that would foolish to ignore.

What the heck is going on with the negative yields seen in 5-yr TIPS?

The mass media/blog view seems to be that a negative TIPS yield implies slow or negative economic growth/deflation ahead. I have a different perspective on the negative TIPS yield. The rate of return by the investor in a TIPS bond is determined by the coupon as set by the market at issuance plus the adjustment made to the principal amount of the bond as determined by the Government-calculated Consumer Price Index. In theory, the total rate of return over any 6-month period should equal the rate of inflation in the economy, thereby giving the the TIP security the quality of preserving purchasing power of money invested. But does anyone really believe that the cost of living over the past year is equal to the 1.3% that is reported by the Government? Reeeally?

So, why would you pay a price for a 5-yr. TIPS bond which starts you out with a negative yield? Those who have suggested that a negative yield implies that the market is forecasting deflation are wrong. The way a TIPS return is calculated, in the event that the CPI were to go negative, the principal amount of your investment would decline. Who would invest in that? I guess Dennis Gartman might.

The only reason I can think of that a sophisticated investor would buy into an inflation-adjusted investment at an initial price which yields a negative return is because the investor believes that there will be substantial positive principal adjustments between now and the maturity of the bond 5 years later. In other words, the investor believes that even the fraudulent Government-calculated CPI will have to reflect much higher levels of inflation in the near future. There can be no other rational explanation. Hell, even Warren Buffet is now warning about inflation, so the smart money must see something that monkeys on CNBC and in the mainstream financial advisory/money management business can not.

Those of us who understand that the Fed/Govt is inextricably painted into an inflate or collapse corner also understand that today's asset deflation (mainly housing and banks) will lead to Bernanke's attempt inflate/hyperinflate the money supply to fight this deflation. Otherwise his famous speech in 2002 was a complete lie.  While Treasury bonds may seem like a relatively safe-haven right now, the only way to protect yourself from the impending credit crisis part deux and concomitant acceleration in inflation is to load up on physical gold and silver.