March 23, 2008

Treasury Market Bubble

The treasury market is so overvalued that some can actually call it a bubble. Since mid last year the long term yield have gone down from 5.13% , its peak since 2001, to currently multi year low of 4.16%. More importantly treasuries are yielding negative real returns.

Investors in the debt markets have actually given up on investing; they are accepting negative real returns for the safety of their principal. They are not willing to accept any risk or uncertainty for that matter. They are paying the US government to guard their money. As you can see in the chart the 30 year treasury real yield (30 yr bond less inflation) has turned negative towards the end of 2007. The last time treasuries had negative real returns was in the early 1970s when the US was battling high inflation rates.

The situation in the credit markets is nothing less than sheer panic. It has thrown all sort of spreads on debt instruments to levels that borders on irrationality. Municipal bonds, which are tax free, are yielding better than the unfavourably taxed treasuries. Triple A rated corporate debt is yielding a healthy 2% spread over equivalent maturing treasuries. Commercial real estate triple AAA rated bonds are yielding unprecedented 3.35% spread. There are a lot of opportunities in the panic stricken credit market but treasuries are not one of them.

The credit market have to readjust and accept risk again and once it does treasuries are going to come down hard. I have sold a big percentage of my government bond holdings to stay away from the impending devaluation. Corporate debt and commercial real estate debt offer better risk adjusted returns as I am willing to accept the uncertainties of the debt "deleveraging" from the system.

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