Why You Should Consider Owning Treasuries
It seems that investors are convinced that interest rates are rising, no matter what their economic outlook is. Those who believe that there is an economic recovery argue that there will be a “great rotation” from bonds into stocks, and this will cause bond prices to fall. Those who believe that there is no economic recovery argue that the United States will have trouble paying its bills and it will be forced to pay higher interest rates to borrow money. There are also those who believe that inflation is coming and that interest rates have to rise in order to reflect the falling value of the dollar. All of these positions, coupled with the simple historical observation that interest rates have never been as low as they are now except in the past few years, point to a mass consensus that investors should sell Treasuries.
This is an excellent reason to consider going long. When everybody is of one belief and on one side of a trade, the risk/reward favors the other side of this trade. In the case of Treasuries there doesn’t seem to be anybody left to develop a negative sentiment and go from owning them to selling them, or even shorting them. Furthermore, while the Treasury bears may have a strong fundamental case, there are several short-term factors that indicate a potential upswing as we look at supply and demand factors.
Regarding demand, the most obvious source is the Fed, whose ongoing quantitative easing program leads it to purchase $40 billion worth of long-dated Treasuries monthly. The Fed also replaces Treasuries when they mature, and it uses interest payments it receives to buy more. In all, from November 2012 through November 2013, the Fed purchased more than $500 billion worth of Treasuries, and it is still the world’s largest buyer. Furthermore, there is still significant Asian demand, most notably from China and Japan. The Chinese added over $130 billion worth of Treasuries last year, and the Japanese added $68 billion.