Global Macro Notes: Did PIMCO Mark a Bottom in Treasuries?
In a very news-heavy week, a notable item was PIMCO’s decision to purge U.S. government debt from its flagship fund.
As Bloomberg reports,
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., eliminated government-related debt from his flagship fund last month as the U.S. projected record budget deficits.
Pimco’s $237 billion Total Return Fund last held zero government-related debt in January 2009…
Gross, the original “bond king,” has taken up the cause of the vigilantes in his monthly investment outlooks. He has warned repeatedly that debt levels are too high, and has openly wondered who will keep buying USTs when the Fed finally stops. Now PIMCO has put its money where its mouth is.
But is this “alarming sign” (as many have deemed it) really a harbinger of looming armageddon for Treasuries? Or is it the mark of a medium-term bottom? Quite possibly it is neither, of course, but the “bottom” case is intriguing…
Two Kinds of Volume
First note the general importance of volume. Surges in volume tend to mark the beginnings and endings of a move, for reasons that are easy to grasp. A major volume increase can signal forward thrust ushering in a powerful a new trend… or it can be a sign of exhaustion, as the firepower of an existing move is spent in one final blast of sentiment.
Another type of “volume” — the type associated with people talking loudly, and betting loudly — tends to mark contrarian turning points. High profile moves telegraph conviction, capitulation, or media saturation, depending on the circumstance.
A recent example of this was value investor Whitney Tilson publicly covering his Netflix short near the top of the hype cycle. Today’s example may be PIMCO dumping USTs in the trough of a “risk on” equity run.
What evidence for a near term bottom in bonds? From a chart perspective, we have a T-bond low registering in February, as viewable in both the futures and TLT, the Lehman long bond ETF.
How ironic that this price action lines up with PIMCO finishing its selling…
In addition to the near-term price action, we have the multi-year chart as shown at the beginning of this piece. The bond bull, which is not just years old but decades old, still has its long-term (VERY long-term) trendline intact.
Now back to the “volume” issue — the loud public pronouncement kind. The bond vigilante case is powerful and solid. It has been echoed by not just Gross, but many other clear-eyed, risk-aware observers — like Nassim Taleb, who said roughly a year ago that “Every human should short U.S. Treasuries.” (Leaving whom to take the other side?)
From a trading perspective, isn’t this widespread consensus part of the problem? If everyone knows that U.S. Treasuries are an obvious disaster, then who is left to sell them? Can one really say, at this late date, that firm opinions on America’s dire financial straits have not yet been “priced in?”
In that respect, news of PIMCO’s government debt blowout feels more like a piece de resistance — a final blast, rather than an opening salvo.
Knowns and Unknowns
Now let’s look at the debt question from another angle. There are “known knowns, known unknowns, and unknown unknowns,” as the accidental poet Donald Rumsfeld liked to say.
And most all of Gross and PIMCO’s objections — at least as recounted in the monthly investment outlooks — are of the “known knowns” variety.
In other words, we know the case against USTs — the “known knowns.” But what about the factors that counter that?‘
Here are some off-the-cuff examples of “known unknowns” that quickly spring to mind:
- What true UST alternatives exist? If the world is to leave US Treasuries, where will the money go instead? Will trillions flow into gold, a market that is tiny in comparison? Really? Will that ocean of capital flow into emerging market bonds, even when so many E.M. nations are locked into mercantilist export policies with incomplete domestic demand transitions? Will central banks sitting on mountains of dollar-denominated reserves, not least China, be so quick to change their stripes?
- What future for emerging market exporters? A defining feature of the present financial age is “currency war” by managed means — export countries absorbing large quantities of dollars (and U.S. government securities) in order to keep the relative value of their own currencies down. This dynamic will have to continue, it would seem, until a full-fledged domestic demand transition is assured. But that hasn’t happened yet… which means these exporters can’t afford to let their currencies rise sharply just yet… which means they can’t stop buying dollar-denominated assets just yet. And thus bonds.
- Can the world handle a too-weak dollar? The logistical reality is that treasury bond prices are infinitely supportable by the Federal Reserve. That is because the Fed can conjure an infinite supply of dollars with which to buy them. Through this mechanism, dangerous weakness is transferred out of bonds and into the currency. As such, a weak bond problem is really a weak dollar problem. And yet, given Europe’s troubles, and the further need of E.M. countries to hold their own currencies down, the world can only handle so much $USD weakness. As John Connally once told the Europeans, “the dollar is our currency but your problem.” Today it is everyone’s problem.
- Can the deflation case really be dismissed? Unfortunately not. Even now, at this late date, the risk of deflation looms large. High-priced oil is a two-edged sword: It threatens inflation and pass-through price increases on one side, yet economic slowdown and spending reduction on the other (by acting as an input and consumption tax). Meanwhile it remains unclear whether Europe will muddle through… or whether China is due for a hard landing… or whether America’s housing market will double dip and the stimulus pop will fade. With deflation still in the fight, so are bonds.
- Where will baby boomers allocate their retirement funds? After a two-year market rally, the “little guy” is finally putting his toe back in the water. Reluctant small investors are being gingerly persuaded to put capital back to work in markets. But what happens if (or rather when) the trap slams shut again and a gut-wrenching correction occurs? Are up and coming boomer retirees, so financially battered and bruised, really going to be anxious to get back in that game? And where will they stash their under-nourished savings (other than bonds)?
- What options remain in a time of true crisis? Where will the world go in the event of another financial heart attack? Are the precious metals markets anywhere big enough? Can the euro really qualify, when European debt issues are as likely to cause the next problem as remedy it? And can China’s currency really qualify, not yet convertible, not yet fortified by true domestic demand, and attached to an opaque regime whose own leaders question the validity of published economic data?
This is not meant to be a table-pounding case for buying Treasuries. We are not long USTs, nor chomping at the bit to become so. (And for those who want to shout about how fiscally irresponsible America is — we know. We have argued much the same.)
And yet the PIMCO blowout, taken by so many pundits as an omen of U.S. debt apocalypse, seems more likely a different kind of sign… a sign that Treasuries may be “sold out” for now. It would not be extraordinary to see USTs rise from here, at least in the medium term.