Shorting US Treasuries

Macroeconomics has always been part of our blog's discussions in our attempts to profit from trends. Over the last year I have had internal debates about whether inflation or deflation will predominate our investing landscape and how do we invest accordingly. I have been very much a gold bull for most of my investing career but recent events have me wavering!

To summarize the arguments for continued deflation: longest and largest credit expansion in history has to be repaid, de-leveraging in general, worldwide economic slowdown, physical limits to the growth of fossil fuel supply.

The arguments for inflation follows this line of thinking: monetary and credit expansion by central banks, coordinated and competitive devaluation of national currencies, continued increases in energy input costs.

Although recently the scales have been tipping into deflation, the overall outcome is hard to predict. Can there be an investment that can capture both outcomes with less risk? Recently there has been a massive flight to safety with an incredible rally in the $US as well as US Treasuries. This has been a normal response many times in the past and yields recently on short term US Treasuries have been close to zero. Investors are willing to accept almost a zero real rate of return (and possibly negative) for the assurance of return of capital.

So one option is to do like other investors and buy government T-bills. If hyperinflation (unlikely) prevails you get less real capital back. If there is just modest inflation then your return is small to zero. It there is deflation you win.

What if there was a way to short US Treasuries? The reasons for shorting is an expectation of higher rates of interest for the US government in general. The bailout packages and nationalization of private business has been unprecedented and all this money needs to be funded by selling more US Treasuries. The US debt keeps climbing and its fiscal position has never been worse. So my thesis is that even without inflation, the US faces higher interest rates and potentially much higher. I am unaware of many ways to play this aside from buying the Proshares short fixed income ETF's. They have two - PST which tries to replicate the inverse of the 7-10 year Treasuries and the TBT which replicates the inverse of the 20+ Treasuries.

If inflation takes off due to all the re-inflationary efforts of the Fed and Treasury and government, then bonds will sell off. If deflation continues to ravage the economy there is a boundary of coupon rates that should provide a ceiling on how high these bonds can be bid. Some short term US Treasuries are already close to zero percent yields, and the official Fed rate of 1.5% isn't that far off from zero either.

There are probably other ways to play interest rates in the futures markets but I don't know how at the moment.