Roller coasters can be arguably fun. US debt has been on some real thrilling one over the past decade. US treasury investors might feel a bit giddy though.
The current shambolic debate about US spending can relate to the exceptionally lavish past decade, from Quantitative Easing (QE) to military spending to infrastructure investing. In absence of fiscal discipline, this has led to larger Government deficits.
In a period of higher rates, national debt service accounts for $700bn annually, or 2.6% of GDP. As we seem bent on rates being higher for longer, and debt to increase by clips of $2TN annually, the debt service burden is unlikely to subside.
“Bonds are back”, or rather the thrill in the bond market is back as volatility is likely to increase.
Traders take positions. Hedge funds, as previously explained here, are keen to make the spread between the 2-year and the 30-year treasuries. Retail investors also relished in the 5% yield on short-dated treasuries, which is now more attractive than the yield on S&P500. It makes for an overcrowded short-end, and lack of buyer’s liquidity on the long-end.
Now a new battle front opens up, the 30-year treasuries. On one side, hedge funds take the short as part of they spread trade. On the other, retail investors take the long, punting on a downtrend reversal. The trade is actually discussed on r/wallstreetbets on Reddit.
Sounds familiar? it’s a stark reminder of the brawl that pitted hedge funds against retail investors in the AMC and Game Stop meme-stock saga, as shown in the movie “Dumb Money”. Spoiler alert: it didn’t end well. This time, the meme stock is TLT, an Exchange Traded Fund taking exposure in 20+ year US treasuries. The latter fell by ~50% since early 2020.
This time is different. The way this trade will tilt will not only change the fortune of some hedge funds, and retail investors, but can also upset the main protagonists here: the US Treasury and the Fed.
It plays on a background of existing budget weakness, and increasing debt supply. At a moment where rates are higher and policy decisions are at a tipping point. When liquidity is tightening, and future demand for US treasuries is put into question, as the main donors Japan, China and the Fed reduce their positions. What could possibly go wrong?
I am by all means not prescient, but something tells me that you should stay well clear of the long-end of treasuries. This will make for an interesting sequel to “Dumb Money” though.
Stay safe out there !
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