How to Short US Treasuries will likely become the “idea du jour” as the year progresses, especially if market conditions start to improve or if inflation returns to even average levels. With new alternative investment instruments allowing for easy inclusion in this process of going short Treasury bonds, everyday investors will have access to this strategy as opposed to prior recessions. The question is whether it’s too early now to cash in on this trend and whether the economic outlook is going to deteriorate further, which could send prices of US Treasury bonds even higher.
The case for Going Short Treasuries:
- The unprecedented move by the FOMC in December to cut the Fed Funds target rate to virtually 0% highlights the dire concerns about further deterioration of global economic conditions. However, there’s no more room to go. With the Fed Funds target rate this low, there is no further opportunity to cut further, so Treasuries will not be impacted by any further cuts.
- Short term yields on Treasuries are close to zero. In fact, Treasury note yields actually went negative during the back half of 2008. While this seemed like a suitable option for investors in the midst of a complete market meltdown when they needed a guaranteed safe haven for near term liquidity requirements, this is likely not a prudent, sustainable investment option for money managers. Looking out into the future, it’s likely that investors will tire of 0% or negative returns on their cash and their funds will find new avenues for low risk income.
- Our country’s insatiable appetite for debt, bailouts and trade deficits is obviously not bolstering the case for the US dollar. While the dollar showed a brief rally during the economic collapse because we exported so much of our toxic waste assets to other countries, this again, was a one time event. We will not be exporting toxic mortgage assets to Swiss banks, the Dubai investment authority and British banks 5 years from now. However, we will still be reeling from the bailout bonanza, importing more than we export, and borrowing more than we make…it’s the American way! This translates into a further weakening of the US dollar. Where’s this all going? – Foreign investors will be less likely to buy Treasuries moving forward, especially as global economic conditions improve, since they will perceive the future value of their investment as declining in terms of their own currencies. If the US dollar’s going to drop, they’ll be less inclined to buy Treasuries and the Short Treasury play will be viewed as prudent.
How to Short Treasuries:
There are a few ways to execute this strategy:
Update #1: There is now a 3X Short Treasury ETF - see full list of all 3X long/short ETFs and associated risks.
Update #2: Another way to play the US prospects and the weak US Dollar vs. other stronger economies is through various Currency ETFs (full list of all currency and leveraged currency ETFs)
Proshares Ultra Short 7-10Yr Treasury (PST) - Twice the inverse of the daily performance of the Lehman Brothers 7-10 Year U.S. Treasury index.
Proshares Ultra Short 20 Yr Treasury (TBT) – Twice the inverse of the daily performance of the Lehman Brothers 20+ Year U.S. Treasury index.
Rydex Inverse Government Bond Strategy (RYJUX) – Inversely correlates to the price movements of the 30-year Treasury bond.
Risk/Benefit of Going Short US Treasuries
It appears as though there’s a unique balance between low downside risk and high upside risk on this short treasury play since there isn’t really much further for Treasuries to go being that the yields are teetering on a loss. However, as conditions improve (which they ultimately will, it’s just a matter of when), and as Treasury bond prices return to parity, these investments will rise substantially. Note that the ETFs cited are 2X inverse equivalents, so near term rallies in Treasuries could result in rapid drops in share prices.
What are your thoughts? Time to Short or do Treasuries have more room to run?
Disclosure: Currently long TBT since the 3X Short Treasury ETF was not available yet at time of purchase.
Update: Have since closed TBT at $55 per share since I don’t recommend holding leveraged ETFs long term.
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I Like the new site, been following EDF for months now, looks like i’ll have to add Darwin’s Finance to my must-read blogs. Keep up the good work! I did quite well with SDS/SSO in the past month and would have never even knew there were EFT’s like that had you not wrote about it. Thanks!!
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I think 10-year+ government bonds are in a bubble but I’m not sure I’d short them. Or maybe do some clever pairs trade. The news is so unremittingly dire it’s possible yields could fall even further from here. The blood isn’t *really* on the streets yet, compared to what the market is saying.
If you can excuse me a link, I wrote a less expert article than your own here, which you may find of interest:
http://monevator.com/2008/12/08/government-bonds-an-exciting-new-way-to-lose-money-to-the-bear/
(I think it’s relevant but please do feel free to delete if you don’t like links in comments, no offence taken!)
Came here via your ‘submit your posts’ post on EDF, love the Darwin spin.
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Two questions about shorting Treasuries, which seems obviously wise, which makes me skepitical, and the waiting period for these kind of trades can be very very long. I was short the EURO for a very very long painful time, for instance. That said:
The inverse and especially the leveraged inverse funds: How do you avoid the daily negative compounding risk? You can lose money on these things if they don’t go almost straight up.
At interactive Brokers, you can short Treasuries, actually Treasuries, not futures, with as small a lot size as 1. That’s $1000. So which bonds should I do? And if I short a 20 year at say 122 and have to pay out 1 percent interest or whatever the coupon is on a 20-year, then do I only make money short-term with price. Forget holding for 10-20 years and waiting to plummet below par? Is below par a possibility? Any bond traders out there?
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Chrisfs Reply:
May 6th, 2010 at 10:06 pm
@Kirribilli Capital,
Are you still short the Euro ?
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I’d like to short treasuries, but more importantly I want to short sell derivatives (of any and every kind)! how do I short sell a put derivative, ie similiar to what buffet is doing or better, short sell a call derivative on treasuries .,,, is that possible? If you know, please let me know at stan_whatmough@hotmail.com
Stan
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Hi Stan,
I think what you’re referring to is selling naked puts and calls. What Warren Buffet did was he sold tons of puts on major US indices, collected billions in options premium, and then when markets lost half their value in unprecedented fashion, he was looking at Billions in paper losses. Fortunately for him, these contracts aren’t callable yet and he’ll likely recover. If around say, 2015, indices are down 30% from where they’re at now, if he’s still around, there are going to be a lot of very angry investors at the annual Omaha convention.
First off, before selling naked (uncovered) calls or puts, you need to really understand all the risks involved, as there are many. You have massive downside with the puts and unlimited downside with calls. There’s a place for every strategy though and I’ve done both. Just understand your liabilities in worst case before employing…please!
Here are some posts outlining my options strategies and how they’ve panned out.
1 day payday on Earnings Volatility (Google Options)
Credit Spreads for Income
Apple Covered Calls-Roll Over for Income Routinely
Financials Volatility Options Play
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I was advised that the transaction costs in 2x or 3x short ETFs were high enough to negatively affect returns. The trader said he wouldn’t sit in a ultrashort ETF position for long, only use it to provide brief offset. Any comments?
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Raymm,
While I agree that the 2x and 3x are not good long term holds (check out my article on The Riskiest ETFs on Earth: http://www.darwinsfinance.com/riskiest-etfs-earth-3x-returns/ ), if there is a rapid, sustained trend, the ETFs do continue to outperform the underlying, which is what happened with TBT. I stuck with it until last week, selling in the high 50s making a handsome profit.
I disagree with the advice that this is due to high fees though. The annal fees are negligible compared to the mathematical certainty that over time, volatility degrades the share price of leveraged ETFs due to daily rebalancing. This is outlined further in my article. Outcome is the same, but underlying reason is a bit more complex than fees.
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I can see how TBT is not a good long term investment. Shorting TLT appears to be better for a long term strategy, as its value seems to keep better pace with the underlyings. But is it the best? What about shorting individual long term Treasury zero coupon Strips? Can they be shorted and held as shorts long term? What would be the most cost efficient way of shorting treasuries for the long term?
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I want to buy an instrument to hold for 5 to 10 years that pays the inverse of a US 12-month bill and resets every 12-month
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Rob Joseph Reply:
August 16th, 2010 at 10:39 am
@RL,
Hey, just found your comment, and you are looking to do the same thing I am. Your comment is from October 7, 2009, so I’m wondering if you ever found the right instrument to make this trade. If so, I’d appreciate your sharing it with me. Thanks.
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