“Treasuries are the latest bubble”. You hear it ten times a day on CNBC, read it in the financial press, hear it at cocktail parties (if you hang with a groovy enough crowd). Okay, they’re pretty rich and offer little value at present levels. That is precisely as designed by the Federal Reserve. The idea is to move investors out the risk curve and away from the risk-free rate of, in this case, no return. That will reliquify the clogged arteries of finance, the theory goes.
Quantitative ease has barely begun and already investors are looking to fight the Fed. Bad idea. Investors are already looking for an outbreak of inflation in the face of the most severe global deflation since the 1930s. Bad idea. Take a look at the chart below of the 10-year Japanese Government bond (JGB). It has spent nearly a decade between 1% and 2% in yield with a few outliers. A bubble? Perhaps, but one that has been extremely slow to deflate.
We are likely in the very early stages of a similar set up in the US, one that won’t last a decade, with any luck, but will surely last longer than the bubble heads can hold short positions in Treasuries, with over 200 basis points of negative carry working against them day after day.
What are the impacts on the dollar? In the early stages, probably dollar weakness as the market continues to fret that the US will have trouble funding its growing debt. In the medium-term, deflationary forces will likely strengthen the dollar just as inflationary forces weakened it earlier this year.
