The Great Treasury Bond Crash of 2010 Has Begun

The Great Treasury Bond Crash of 2010 Has Begun.

The most spectacular bear market of the 21st century has started. We are now three months into a major long term secular trend that I believe will continue for decades. Many of the brightest minds in international finance have already put size positions on. The early adopters will make fortunes.

The trigger for the next leg down in bond prices is the surprise announcement overnight of a compromise on an extension of the Bush tax cuts. Dividends and capital gains will continue to be taxed at a 15% rate. Estate taxes are capped at 35%, and are tax free up to $5 million. Unemployment benefits have been extended by 13 months. And to really juice consumer spending, payroll taxes have been cut by 2%. You can really see that it was an “all of the above”, throw in the kitchen sink sort of compromise.

Politicians and taxpayers alike are popping open the champagne bottles. I’ll tell you what the Treasury bond market sees: an increase in the 2011 budget deficit of $450 billion and a massive surge in government borrowing and Treasury bond issuance. This is why bond prices have fallen off a cliff today, and shorts bond plays are through the roof.

To say that things have gone well for the Treasury bond market this year would be a huge understatement. First, there was a global flight to safety triggered by the European debt crisis in the spring. Then we saw the mad rush by hedge funds to cover shorts in securities they believed were the world’s most overpriced assets. Out of nowhere, Ben Bernanke appeared on the scene with his quantitative easing. The perfect storm sent bond prices everywhere to 50 year highs, and yields to all time lows.

The recent action in the markets suggests that the turn may finally be behind us. Why have bond prices been falling for the past three months, despite an assumed promise by the Fed to provide unlimited amounts of liquidity? Why has a ton of Chinese and other foreign buyers failed to propel prices to new highs? Is it possible that the fat lady is at last singing in the Treasury bond market? Instead of driving bond prices higher, the true net effect of QE2 could be merely to slow their descent. In November, 99 consecutive weeks of bonds fund inflows came to an abrupt halt, and have seen only outflows since.