I spent minutes staring at this: the US 10yr Treasury Bond finished the day at 1.99%. I want the reader to first step back and think about the inherent paradox of investors buying a downgrade, and secondly, consider what a current and continued low rate structure implies.
Paradox
Last month, S&P downgraded the US’s sovereign credit rating from AAA to AA+ (with a negative outlook). Since then, the US 10yr Treasury Bond yield has fallen from 2.40% to 1.99%. This means that as US credit is officially considered to be worsening, more investors are buying it! The opposite is normally true: when a country is downgraded, investors normally demand higher compensation for lending funds to that country. In the US’s current situation, the country suffered a downgrade and investors now demand less compensation for funds lent–quite the paradox! I believe this situation to be unsustainable.
Implications
Suppressing interest rates to abnormally low levels both hurts the economy and the currency. My assumptions are as follows:
- An economy is based on what it produces
- New sources of production depend on businesses investing in capital expenditures
- Financing for capital expenditures depends on another party saving money (forgoing consumption)
- Saving money requires an incentive of high interest rates
AND
- Printing money to enable low rates (via purchasing treasuries) devalues the currency
- A devalued currency appears as broad-based inflation with increased commodity prices
Today’s Trade
I argue that the economic malaise, devalued currency, or both, will not be tolerated over the next few years. I have already established investment positions for an economic downturn, and I have multiple positions that hedge against the US Dollar (see Commodities and Coins allocation in this pie graph). Today’s trade directly attacks the yield curve. I strongly believe that the US 10yr Treasury Bond will yield significantly higher than 1.99% in a few years. I choose to short the 3-7 year portion of the curve by shorting 15 shares of IEI, which is a bond fund ETF mimicking the Treasury Yield curve, at $121.70. Ideally, I would have like to have also shorted IEF, which is the 7-10 year portion of the curve, but shares of the ETF were unavailable for shorting; I may revisit this next week… And for those of you who are long-time followers, I still own JFR and would consider purchasing more at a lower price.
