Shorting Treasury Bonds

by Wes Bridel on October 1, 2010

in Stewardship

Shorting Treasury Bonds is a way to directly speculate on higher interest rates and inflation.  We’ve been discussing asset management in a crazy economy. The last several posts have been about the effects of inflation on bonds and how it affects you.  Today, we’ll discuss shorting Treasury Bonds.  As we’ve said many times, we believe that a sinking Dollar and rising interest rates will be the trend of our lifetimes.  If this is correct, then you must be on the right side of this.  The difficult part is knowing when it will happen.

If you believe that significant inflation and perhaps hyperinflation is coming, you can buy ETF’s which seek to mimic the opposite (or a multiple of the opposite) of the performance of a certain duration of US Treasuries.

Remember, the value of bonds go down as interest rates go up.  If you have a security which does the opposite of this, then it will go up as interest rates go up.  The longer duration the bond (Ex. 30 yr as opposed to 10 yr Bonds) the more dramatic the effect will be.  But remember, this effect works in both directions.  If interest rates continue to go down, bond values will increase and the value of your inverse Bond security will decrease.  The longer duration of a bond, the more your value will decrease.  You can look at longer duration inverse bond funds as a more leveraged play (both positive and negative) on interest rates.

We’ve seen much of this over the past couple years.  You might think that because the US economy has been in such turmoil and the US Government has tripled the number of US Dollars which exist and borrowed money at unprecedented levels, the US Dollar would fall and interest rates would have been rising already.  However, we live in a very complicated and integrated world economy.  Yes, that is the correct assumption in a vacuum, but this has not happened yet because the other major countries, governments, and economies of the world have done very similar things.

When people got scared, they rushed to put their money with Treasuries because they still think of these as safe.  When the next financial earthquake hits, they could well do the same.  When more lenders show up at the Treasury auctions to lend, interest rates go down and bond values go up.

It will take a major change in thinking of the world’s investors in order to see this big shift we are predicting.  And this is why it is so hard to predict when this happens.  Because of this, we think it will happen quite abruptly.  This is not to say that it will all happen at once, but that the value of the US Dollar will fall quite steeply when this finally begins to happen.

If this area of speculation intrigues you, you must decide how you want to participate…

1)      Maybe you view it as a long term trend that you want to be in and forget about?  In which case, you can simply buy in, knowing that there is a good chance you will slowly lose value in your position until the change comes at which point you will make it all back and considerably more.  This is the best option if you are convinced that the trend will happen, but don’t have the time to watch the market on a weekly or monthly basis.

2)      Perhaps, you’d like to watch and see the trend establish itself first and then take a position for the majority of the ride.  This could turn out to be the best way to play it if it takes a substantial amount of time for higher interest rates to show up.

3)      Finally, you might decide to take a 1/2 or 1/3 position.  Then you could take another 1/3 if you see an incredibly low bottom formed (such as 10 year bond interest rates around 2%) and take the final 1/3 (or your remaining ½) as you see the trend formed (perhaps 10 year bond rates above 4%).  This might be a good way to both watch the action with money at stake and not miss any potential surge in interest rates, while still allowing you to have more money to allocate as the environment changes.

We’ll next look at the ways financial companies might react in inflationary environments.  If you have any thoughts or questions on this or other topics, please let us know.

Shorting Treasury Bonds is a way to directly speculate on higher interest rates and inflation. We’ve been discussing asset management in a crazy economy. The last several posts have been about the effects of inflation on bonds and how it affects you. Today, we’ll discuss shorting Treasury Bonds. As we’ve said many times, we believe that a sinking Dollar and rising interest rates will be the trend of our lifetimes. If this is correct, then you must be on the right side of this. The difficult part is knowing when it will happen.

If you believe that significant inflation and perhaps hyperinflation is coming, you can buy ETF’s which seek to mimic the opposite (or a multiple of the opposite) of the performance of a certain duration of US Treasuries.

Remember, the value of bonds go down as interest rates go up. If you have a security which does the opposite of this, then it will go up as interest rates go up. The longer duration the bond (Ex. 30 yr as opposed to 10 yr Bonds) the more dramatic the effect will be. But remember, this effect works in both directions. If interest rates continue to go down, bond values will increase and the value of your inverse Bond security will decrease. The longer duration of a bond, the more your value will decrease. You can look at longer duration inverse bond funds as a more leveraged play (both positive and negative) on interest rates.

We’ve seen much of this over the past couple years. You might think that because the US economy has been in such turmoil and the US Government has tripled the number of US Dollars which exist and borrowed money at unprecedented levels, the US Dollar would fall and interest rates would have been rising already. However, we live in a very complicated and integrated world economy. Yes, that is the correct assumption in a vacuum, but this has not happened yet because the other major countries, governments, and economies of the world have done very similar things.

When people got scared, they rushed to put their money with Treasuries because they still think of these as safe. When the next financial earthquake hits, they could well do the same. When more lenders show up at the Treasury auctions to lend, interest rates go down and bond values go up.

It will take a major change in thinking of the world’s investors in order to see this big shift we are predicting. And this is why it is so hard to predict when this happens. Because of this, we think it will happen quite abruptly. This is not to say that it will all happen at once, but that the value of the US Dollar will fall quite steeply when this finally begins to happen.

If this area of speculation intrigues you, you must decide how you want to participate…

1) Maybe you view it as a long term trend that you want to be in and forget about? In which case, you can simply buy in, knowing that there is a good chance you will slowly lose value in your position until the change comes at which point you will make it all back and considerably more. This is the best option if you are convinced that the trend will happen, but don’t have the time to watch the market on a weekly or monthly basis.

2) Perhaps, you’d like to watch and see the trend establish itself first and then take a position for the majority of the ride. This could turn out to be the best way to play it if it takes a substantial amount of time for higher interest rates to show up.

3) Finally, you might decide to take a 1/2 or 1/3 position. Then

Shorting Treasury Bonds is a way to directly speculate on higher interest rates and inflation.  We’ve been discussing asset management in a crazy economy. The last several posts have been about the effects of inflation on bonds and how it affects you.  Today, we’ll discuss shorting Treasury Bonds.  As we’ve said many times, we believe that a sinking Dollar and rising interest rates will be the trend of our lifetimes.  If this is correct, then you must be on the right side of this.  The difficult part is knowing when it will happen.

If you believe that significant inflation and perhaps hyperinflation is coming, you can buy ETF’s which seek to mimic the opposite (or a multiple of the opposite) of the performance of a certain duration of US Treasuries.

Remember, the value of bonds go down as interest rates go up.  If you have a security which does the opposite of this, then it will go up as interest rates go up.  The longer duration the bond (Ex. 30 yr as opposed to 10 yr Bonds) the more dramatic the effect will be.  But remember, this effect works in both directions.  If interest rates continue to go down, bond values will increase and the value of your inverse Bond security will decrease.  The longer duration of a bond, the more your value will decrease.  You can look at longer duration inverse bond funds as a more leveraged play (both positive and negative) on interest rates.

We’ve seen much of this over the past couple years.  You might think that because the US economy has been in such turmoil and the US Government has tripled the number of US Dollars which exist and borrowed money at unprecedented levels, the US Dollar would fall and interest rates would have been rising already.  However, we live in a very complicated and integrated world economy.  Yes, that is the correct assumption in a vacuum, but this has not happened yet because the other major countries, governments, and economies of the world have done very similar things.

When people got scared, they rushed to put their money with Treasuries because they still think of these as safe.  When the next financial earthquake hits, they could well do the same.  When more lenders show up at the Treasury auctions to lend, interest rates go down and bond values go up.

It will take a major change in thinking of the world’s investors in order to see this big shift we are predicting.  And this is why it is so hard to predict when this happens.  Because of this, we think it will happen quite abruptly.  This is not to say that it will all happen at once, but that the value of the US Dollar will fall quite steeply when this finally begins to happen.

If this area of speculation intrigues you, you must decide how you want to participate…

1)      Maybe you view it as a long term trend that you want to be in and forget about?  In which case, you can simply buy in, knowing that there is a good chance you will slowly lose value in your position until the change comes at which point you will make it all back and considerably more.  This is the best option if you are convinced that the trend will happen, but don’t have the time to watch the market on a weekly or monthly basis.

2)      Perhaps, you’d like to watch and see the trend establish itself first and then take a position for the majority of the ride.  This could turn out to be the best way to play it if it takes a substantial amount of time for higher interest rates to show up.

3)      Finally, you might decide to take a 1/2 or 1/3 position.  Then you could take another 1/3 if you see an incredibly low bottom formed (such as 10 year bond interest rates around 2%) and take the final 1/3 (or your remaining ½) as you see the trend formed (perhaps 10 year bond rates above 4%).  This might be a good way to both watch the action with money at stake and not miss any potential surge in interest rates, while still allowing you to have more money to allocate as the environment changes.

We’ll next look at the ways financial companies might react in inflationary environments.  If you have any thoughts or questions on this or other topics, please let us know.

you could take another 1/3 if you see an incredibly low bottom formed (such as 10 year bond interest rates around 2%) and take the final 1/3 (or your remaining ½) as you see the trend formed (perhaps 10 year bond rates above 4%). This might be a good way to both watch the action with money at stake and not miss any potential surge in interest rates, while still allowing you to have more money to allocate as the environment changes.

We’ll next look at the ways financial companies might react in inflationary environments. If you have any thoughts or questions on this or other topics, please let us know.

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{ 2 comments… read them below or add one }

TerryT 10.11.10 at 4:35 pm

Any recommendations on which ETFs would be best? Maybe that would be a good follow up article.

Thanks

Wes Bridel 10.12.10 at 10:00 am

Thanks Terry, I avoid naming exact securities on the blog because all sorts of people read it. Many are clients who can take the information (talk to me about it if need be) and act accordingly. Others have read every post for over a year and can thus assimilate the information from one post into the overall concepts that have been discussed for a long time, so a little research and take action.

both of those are great. What I would be afraid of happening, is someone coming over, reading one post and taking action that I would never advise if I knew more about their situation, getting hurt, and then blaming me because I gave them the idea. In fact, this is the way that most people make financial decisions and why most people do so poorly in the markets.

So I feel I’m giving away enough information that:
1) Someone who is really educated can take action,
2) Someone else might see an insight that appeals to them and can decide they would like to contact us to get more educated on how to utilize certain concepts, or
3) someone else can do a little more research on their own and of course make any decision they want to make. Hopefully then no one can even think that we’ve led them to make any particular decision. That is certainly not the intent of this blog. We don’t know anything about any person that comes to read this blog and so what might make sense for one would make no sense for another.

Does that seem fair?

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