Lemmings Stoke Flight to ‘Quality’

It takes some getting used to whenever the phrase “flight to quality” pops up in print or on the business shows these days. Supposedly, that is what has been driving Treasury Bond prices sharply higher since June 11, when futures contracts on 30-Year U.S. Treasurys bottomed at 111^21. That equates to a yield of about 4.84 percent. Yesterday the same contract settled at 117^11, so eager were buyers, evidently, to lock in 30-year rates of around 4.37 percent. (For the record, we are predicting that yields on the long bond will fall a further 17 basis points, to 4.20 percent, before this lemming-driven fad feints toward sanity.)

We’re tempted to say the buyers of these bonds are out of their minds, since, in the newsletter world, if not in the mainstream press, Treasury paper is intrinsically worth no more than toilet paper. This isn’t conjecture, mind you, it’s just simple math. Pile up enough trillions in debts, and eventually repayment of those debts becomes impossible. That’s where the U.S. is now, mathematically speaking, even if the institutional biggies who live off the yield curve would prefer to act as though things will somehow turn out better for us all.

 They, Too, Can Read

Actually, in their private lives, T-bond buyers probably have faced the facts. After all, they read the same headlines that you and I read, and they know, as you and I know, that all is not well with the financial system. They know, for instance, that 40 banks have failed so far this year, and that the pace of these failures shows no sign of abating. They also know that so-called quantitative easing has been a failure, since long-dated Treasurys, even when buoyed by a flight to alleged quality, are in real terms close to inflicting a fatal burden on long-term borrowers.  As our colleague Levente Mady at Institutional Advisors notes, real rates are at close  to 6 percent when you factor in a CPI decline from -0.7 to -1.3% year-over-year through May.

 Deflation at Work

That is deflation perniciously at work, and we shudder to think how much worse it could get if the dollar strengthens; for that would make dollars even harder to come by, and to repay. Homeowners with negative equity are feeling the pressure of this acutely, even if institutional investors, in their professional lives, are not. The latter clearly do not base their investment decisions on such mundane realities.  Rather, they are driven by the need to be invested in assets with maturities all along the yield curve. And they are insulated from responsibility simply because it is Treasury paper they are buying, for the love of Mike, not the junk bonds of some corporate zombie. This rationale is highly unlikely to produce losing results over the short term. However, given the speed at which financial crack-ups have been occurring globally, it is clear that we no longer have the luxury of seeing the long-term as something our children will have to deal with. For those who have been snatching up Treasury Bonds, the long-term may not even stretch past 2010.

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