With treaury rates well below their historical mean / median, we should expect them to revert back to normal over time, no?
I know I’m missing something here. Is it just the fact that the Fed is working hard to keep rates low, and I shouldn’t fight the Fed? Is it just that I’ll need to be prepared to wait a long time for the strategy to pay off?
Can someone help uncover my ignorance?
How long are you willing to waith eh? What if rates stay depressed for extended periods? And what’s the upside……?
Cities teem with evil and decay, let’s give it a good shake and see what falls out!!
It’s still not a sure bet. When US 10Y was at 2%, people said it couldn’t get any lower. Today, we are seeing 1.455%. It could be a while before rates rise again.
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Keep in mind the giant debt load on govts in the western world….do you think they want rates to rise….?
Cities teem with evil and decay, let’s give it a good shake and see what falls out!!
Two reasons:
1 - correlation with stocks. It’s useful to have an uncorrelated asset to reduce the risk. That means you can deploy more capital for higher returns given a risk budget. Of course, if you have negative expected returns, low correlation is not a sufficient justification. Taking advantage of correlation effectively also requires some periodic rebalancing.
2 - people have been losing money on the “treasury rates have got to start rising again” for a long long time. That doesn’t mean that treasury rates can’t or won’t rise… it just means that being below the historical average is not a reason - in and of itself - to jump in and short. Remember that while you are shorting, you still have to make interest payments (albeit low ones). I think it may make some sense to curtail risk with OTM puts rather than short treasurys outright.
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because it if goes down another 10 basis points and sits there for a year or more, you will lose
How would you do it? Being short is costly. Unless you think rates are going up in the very near future it would get too expensive.
We know the short end of the curve isn’t moving until late 2014 at the earliest, and the longer end is being manipulated by the Fed as well (QEx/OpTwist). Even without the Fed depressing rates, one could argue the current economic environment would lead to low rates anyway.
Rates will go up eventually. Whenever the Fed starts to unwind their balance sheet…that’s when things are going to get dicey. In the meantime, I’d fish elsewhere.
If you are a big fish, it’s easy to go long rates with swaps. For retail, it’s probably cheapest to do it with short bond ETFs. That’s if you believe it’s a good trade at least.
“I’m a CPA! I got money b***h!”
Yep. I thought about making a bet on this back in February using ETFs and I’m glad I didn’t. I’d be down about 10% by now.
Yeah, I was looking into short bond ETFs. I’ll have to look into puts, as bchad suggested, but I’m thinking ETFs are the way to go here.
If there’s another flight to safety (pick your catalyst), rates could be pushed down further, but I think that could be overcome if my time horizon is long enough.
I’m still thinking it all through, though. That is, what my time horizon is, when to get in/out, what my catalysts will be to trigger higher rates, etc.
if you think rates are going higher, i would suggest you look into a basket of life insurers in Canada (traded on the NYSE)…..if rates rise, those things will pop anywhere near 30%…..
What’s the logic behind the 30% pop in insurers on a rate rise.
It seems to me that when rates start rising, cash is really the only thing to own for a little while.
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The rates on their assets will rise? Presumably, many of them are holding short duration debt anyways, so a bump in rates won’t hurt them substantially, and when they roll over to new issues they’ll do better?
Cities teem with evil and decay, let’s give it a good shake and see what falls out!!
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The market can stay irrational longer than you can stay solvent
How many decades have Japenese bond rates been well below their historical mean?
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I don’t follow the bond market as much as I should. But I think rates are low in part due to the fight to quality - the downgrade of USA actually lowered rates, if I remember correctly. For example, If Europe fixes itself calmly, I could see a lot of money leaving treasuries to go back into other areas of the world. I personally don’t know if it’s the Fed or coicidence for the low rates – generally, I’ve always read/been taught Mr. Bernake only influences short term rates and Mr. Market does the long term rates.
it’s not only US rates that are low. Look at UK, German and Japanese.
I had the same idea earlier this year and bought TBT. I got out quickly and I’m really glad I did. Kyle Bass’ best idea at the Institutional Investor conference last year was to short Japanese Government Bonds. One of the other panelists who was older said something to the tune of “I heard about that trade 19 years ago, and we’re still waiting for it to play out”.
Just thinking out loud…maybe go long high yield and short the treasury market, and that way you can earn the spread but still profit when treasury yields come up.
Short term rates use to affect long term mortgage rates. That trend broke as a world wide “savings glut” began. This increase in lendable funds brought down rates, according to Alan Greenspan in a WSJ article he wrote in response to a WSJ article written by John B. Taylor that criticized the Fed for not following the Taylor Rule prior to and through the crisis
If you do a spread trade with high yield, you are likely to get hurt when treasury rates rise, because the credit spread will very likely widen. However I do like your attempt to think up an alternate trade.
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the reason for the pop in life insurers from a rate rise is because their liabilities with be reduced due to the discounting and the increase in yields on assets supporting those liabilities….
Why would the rate change hit the liabilities and the assets differently? Aren’t they supposed to be more or less duration-matched? Are insurers loaded up on floating rate stuff?
(I’m not being sarcastic, I’m genuinely curious about this)
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Well, he seems to be implying that the assets and liabilities are *not* duration matched.
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That is such a general statement though, you can apply that to any market!
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Yes, that is the implication. I just want to be sure that that’s the implication that was intended and not something else.
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the problem is especially acute for life insurers which have durations that are “unknown” and normally go to 30 years…….also considering the fact many insurers underpriced in the bull market as well….
so no, its not duration matched…..keep in mind there are mortality assumptions built in which are surprising highly unreliable as well…..
Theoretically, there must be a way to hedge these mortality assumptions… life insurance basically says “If I die early, pay me money”. There must be a way to make a contract that says “If I die early, I will pay you money”. If insurers do like 1,000,000 of these contracts, that should offset broad trends in life span at least.
Wow, check that out. Financial innovation right there!
“I’m a CPA! I got money b***h!”
Yes but are the uncertainties in mortality correlated to interest rate changes? Because that is what one would need to see for that to be relevant in an interest rate play.
So the argument presumably is that liability durations can go to 30 years, but there aren’t that many fixed income assets that can do that. There are some 30 y bonds now, stocks can have durations that high, and there are also a few perpetuities. However, assuming that these are hard to find, the assets are more likely to have durations of 8-10 years, while liabilities have closer to 30y.
in that case, I could see the rationale for a pop if interest rates rise. However, that would also imply that life insurance companies have been getting slaughtered throughout the 25y bond market bull run as interest rates go down. That doesn’t seem likely, although I don’t have the data in front of me.
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Best to hedge life insurance with life annuities. In one, you pay more if people live longer; in the other, you pay more if people live shorter.
In general, life expectancy has been extending, so that tends to be good for life insurers and bad for annuity issuers. Of course, with chemicals and obesity and all that stuff, things can change.
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Hmm. That’s a good point. I think one difference between annuities and life insurance, though, is age of customers. Annuities are mostly for old people. Life insurance customers are younger on average. So, annuity payoff will be more sensitive to general changes in life expectancy. I would expect that life insurance is more sensitive to accidents, or sudden manifestation of health problems.
Now, if they could get the old people to buy both annuities and life insurance, that would be pretty incredible…
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