Forget the V's and Focus more on the Two T's

Friday Greetings and Well Wishes to all,

Many technical analysts may be ready to buy the parabolic move the 10 Year T-Note has made over the last six months; a "V" formation crying out for imminent exhaustion, caution: http://finance.yahoo.com/q/bc?s=%5ETNX&t=5y&l=on&z=l&q=l&c= Dynamic forward-thinking money managers like Pimco's Bill Gross refuse to pile in due to the developing drama of where the new normal "T"-rillion dollar budget deficit will stabilize the yield curve, a steep slope resembling one of Jackson Hole's double black diamond runs. Here's what Bill Gross sees developing for treasuries, outside the technicals some traders solely rely on: "The immediate question is who is going to buy all of this debt? Estimates suggest gross Treasury issuance of up to $3 trillion this calendar year and net offerings close to $2 trillion – almost four times last year’s supply. Prior to 2009, it was enough to count on the recycling of the U.S. trade/current account deficit to fund Treasury borrowing requirements. Now, however, with that amount approximating only $500 billion, it is obvious that the Chinese and other surplus nations cannot fund the deficit even if they were fully on board – which they are not. Someone else has got to write checks for up to $1.5 trillion additional Treasury notes and bonds. Well, you’ve got the banks and even individual investors to sponge up some of the excess, but a huge, difficult to estimate marginal supply will have to be bought. The concern is that this can be accomplished in only two ways – both of which have serious consequences for U.S. and global financial markets. The first and most recent development is the steepening of the U.S. Treasury yield curve and the rise of intermediate and long-term bond yields. While the Treasury can easily afford the higher interest expense in the short term, the pressure it puts on mortgage and corporate rates represents a serious threat to the fragile “greenshoots” recovery now underway. Secondly, the buyer of last resort in recent months has become the Federal Reserve, with its publicly announced and near daily purchases of Treasuries and Agencies at a $400 billion annual rate. That in combination with a buy ticket for over $1 trillion of Agency mortgages has been the primary reason why capital markets – both corporate bonds and stocks – are behaving so well. But the Fed must tread carefully here. These purchases result in an expansion of the Fed’s balance sheet, which ultimately could have inflationary implications. In turn, nervous holders of dollar obligations are beginning to look for diversification in other currencies, selling Treasury bonds in the process." In Gross's honesty we find the true conundrum, the force of politics on money and banking on a scale never witnessed before. Convincing foreign governments like China the U.S. credit rating is safe in the face of such unparalleled spending while unemployment and GDP disappoint is cause for concern. Considering Pimco's trading psychology is the litmus test for most in the industry, the fear of trading against governments is evident and clear at Pimco. The Pimco's of the world suddenly look like cubs next to the voracious govt spending tigers. No wonder individual investors are confused; trading against govt printing presses creates confusion... So as tempting as the 10 year treasury note looks from an artistic perspective, think twice before buying today's 3.8%+ yield. It is likely the T-Note sees 5% before 3%, as unemployment and GDP scenarios will not improve overnight. Understanding technical analysis is usually very helpful, yet understanding the psychology driving the yield curve in this new normal environment may trump all investment methodologies. The investment allocation along the yield curve has obviously shifted from greed to fear. Today's less riskless longer-term treasuries are being sold for short-term maturities. Could that suddenly change with this administration's policies, Bill Gross surely sounded skeptical. That "Full Faith and Credit of the U.S. Governement" phrase is not being reflected in the large spread between the 2's and 10's, over 250 basis points or 2.5%. A reason it may be wiser to forget about the "V's" and be more cognizant of the two "T's as the title suggests: the "T"-rillion dollar budget drama ahead and your ability to hedge that inflation danger with "T"ips, Treasury Inflation Protected Securities.

The Psychology of the Call team wishes all a fine June weekend.

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