Beware of Shorting the Treasury ‘Bond Bubble’ (TLT) (TBT)

Beware of Shorting the Treasury 'Bond Bubble' (TLT) (TBT)

Wilbur Ross, president of W.H. Ross & Co., was on CNBC this morning, discussing natural gas, and Federal Reserve policy. He specifically warned about long term treasuries and the risk they pose to investors. Although treasuries have no default risk, Ross warned about rising interest rates.

Ross stated in the interview:

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“I think the greatest bubble that is about to burst is the 10-year and longer Treasury, because the idea that inflation is gone forever and for all time, and therefore these artificially low rates can last, is silly.”

Other famous investors have been issuing the same warnings. Seth Klarman has been shorting treasuries since at least 2010, and has more recently bought deep out of the money puts, which would profit if rates rise significantly.

Investors who want to profit off this trade could buy a few ETFs, which profit when treasuries go down in yield. Among the popular ones are: iShares Barclays 20+ Yr Treas.Bond (NYSE:TLT), ProShares UltraShort 20+ Year Trea (NYSE:TBT).

Besides for the fact that we do not recommend any securities, we also think shorting treasuries might be a big mistake.

Unlike the housing bubble, where the Federal Reserve could only do certain things to avoid a bad down turn, treasuries are different.

The Federal Reserve has defacto control over interest rates. If interest rates increase too quickly, the Federal Reserve can start buying treasuries, in order to lower the yield. Of course, this could have other undesirable effects, however, it seems many great investors lose sight of this fact.

As an example of a bad trade, investors can look at Japan. The country has had ultra low interest rates for 20 years. Many great investors have shorted Japanese Government Bonds in hopes of profiting off rising rates.

Kyle Bass coming off of his recent ‘short’ of Greek bonds, is attempting to do the same with Japense bonds. Kyle Bass bought credit default swaps on Greece for only $1,100, which were later worth $700,000. He is now implementing the same strategy with Japanese bonds. The big difference is that Greece had no control over its own yields, while Japan does. Bass might be the latest great investor to join the crowd who lost money on this 20 year old idea.

Looking at the history of Japan, we would urge investors to be cautious before shorting US treasury bonds. America can control treasury yields as Japan could. Greece was a completely different situation. Will America be different than Japan?