Has any trade over the last few years frustrated more sophisticated investors than the “one-way” bet on rising long-term government interest rates?
For the last 2 or 3 years, many (including myself) have been piling into ETFs (like TBT) that act as short proxies for rising long term interest rates. And the logic has been so sound, it’s maddening!
It’s tough to argue with this sequential logic:
Step 1 – The government piles on more debt than it can handle
Step 2 – Long-term bond buyers get nervous
Step 3 – Interest rates begin to rise due to added risk
Step 4 – Long term interest rates go to the moon as the bond vigilantes ride into town
It all makes perfect sense – except that we’re STILL stuck on step 2!
While I do believe that someday interest rates on long-term government debt must rise as a result of the fiscal profligacy being exhibited by US leaders – it appears that this trade is going to take much longer to play out than many anticipated. In fact, it probably already has.
The only justification I can come up with is deflation. Perhaps deflationary forces are overwhelming all other factors right now. If we were heading into the inflationary environment that many had predicted would be here already, then we’d expect long-term rates to be north of 5% and climbing by now.
One new wrinkle is that, all of a sudden, it seems that everyone is concerned about deflation – not inflation:
- Wall Street Journal Piles on Deflation Bandwagon
- Globe and Mail: Deflation Requires New Strategy for Investors
- Jeremy Grantham: Deflation Has Won
- Bill Gross Also Worried About Deflation
You’d have to think this topic will be on the agenda at the FOMC meeting next week. Can Ben & Co fire up the printing presses before credit destruction takes hold? Will they even be allowed to fire up the printing presses? We shall see!