November 6, 2011

Is the Run in U.S. Treasuries Over?

Today, the future movement of U.S. Treasuries is already being shaped, and again, the crowd and its conventional wisdom will be proven wrong.

In October, stocks had their best monthly rally since 1987. The S&P 500 index (SPY) around 12 percent. And as stocks gained, bonds sunk. Is the bull run in U.S. Treasuries over?  

While European stocks (VGK) have lagged most of the year, Greece has a plan! How many times have we heard that?

Banks holding Greek debt conceded a 50% cut for Greek debt being held by private investors. Bond investors were forgiving with Greece, but will that be that way with other debt saddled countries that want a break?

Panic was caused by the proposed referendum in Greece because polls show that the terms reached with the EU and IMF are highly unpopular with Greek citizens. Even though they have gotten an incredibly good deal, the average Greek is focused on the additional years of austerity that would be required on Greece's part.

Apparently, neither the Greeks, nor the markets like hearing that there is no free lunch.

Meanwhile, the European Financial Stability Facility (EFSF) – Europe’s main weapon against toxic debt contagion - was strengthened. According to some reports, EFSF could provide guarantees up to $1.4 trillion for bonds in troubled eurozone countries.

All of these events have significance to the U.S. Treasury market, no matter how far removed they may seem.  

History, a Few Months Ago

In the face of the U.S. debt ceiling crisis and a downgrade in the U.S. government’s credit rating in August, the Treasury market (IEF) was destined to collapse.

As it turns out, these bold proclamations coming from Treasury bears like PIMCO’s Bill Gross (PTTAX) and others weren’t just wrong, but overblown. 

On July 27, just ahead of the August debt ceiling deadline here’s what ETFguide’s Weekly ETF picks said: “Our first recommendation is to ignore the noise being spread by major media establishments. No matter how much their headlines make it seem that a deal will not get done, the historical odds show the exact opposite. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit. And while losing the coveted AAA-rating is bad, it isn't a total disaster. Even with a downgrade, U.S. debt would still be considered ‘investment grade,’ so by that standard, bond funds and ETFs linked to major indexes would still hold U.S. paper.”

The ABCs of Credit Ratings

The velocity of credit downgrades among sovereign nations around the world has been increasing.

This is especially true in Europe, where debt downgrades have hit Italy and Spain. It’s well understood that both of these countries are too large to bailout in the event of a default. How are these events connected to U.S. sovereign debt?

While future downgrades to U.S. government debt are likely, it probably won’t stop prices from rising. Why?

Because on a relative basis, U.S. debt is perceived as a less risky bet compared to its European counterparts. This is just one of many catalysts that are likely to influence the future direction of U.S. Treasuries.  

Today, the future movement of U.S. Treasuries is already being shaped. And again, the crowd and its conventional wisdom will be proven wrong.

ETFguide’s latest analysis of Treasuries in its ETF Profit Strategy Newsletter looks at long-term Treasuries and outlines three key catalysts for this market. It highlights technical levels for Treasuries and a way for ETF advisors to capitalize.

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