Fundamental Trading Diary

Fundamental analysis of the capital markets

The Case for Shorting Bonds

Bill Cara has claimed that The Trade of the Generation is to sell bonds and to buy gold.  I think he’s right.  Here’s why:

  1. The inflation rate is currently being reported at 3.8%.  Most people think that the books are at least a bit cooked, and some well respected economists even think that we’ve averaged closer to 8% pa since the 80s.  The 20 year rate is currrently 3.487%.  Even going by inarguably understated government statistics, you’re losing money.
  2. The target rate which governments lends money is 1%.  The real lending rates have been dramatically lower — near 0% for close to a year now.  Friday’s weighted average was 0.441%.  Wednesday’s was 0.33%.  This is actually an improvement over earlier in the month where we see the Fed lending at 0.253% on the 4th, 0.195% on the 5th, 0.18% on the 6th….  this is going to serve to increase inflation.

With effective rates at less than 1% and the current backdrop of financial crisis, do you think 3.487% pa reflects the inflation or default risk over 20 years?  I surely do not, and I think the current principle in domestic government bonds is a bubble caused by flight-to-quality and flight-to-liquidity from the bust of commercial bonds.

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November 30, 2008 - Posted by | Uncategorized

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