More Volatility to Come as Treasuries Lose Shine

It’s been an interesting start to 2009.

The stock markets are down over 10% for the month in one of the worst starts to a new year in the last 80 years.

But never fear, you’ve been hiding out in treasuries, right? Because they’re “safe”?

Only last week, we saw the largest decline in the treasury complex in over 20 years.

Beware. The flight to treasuries for safety is probably already over and that ride is going to get very, very rough.

From Reuters:

“Treasury bonds have sold off as markets have started to digest the rapidly growing volume of future government issuance,” said Mohamed El-Erian, chief executive of bond giant Pacific Investment Management Co, or Pimco.

Treasuries performed spectacularly in 2008, returning more than 25 percent in long-maturing bonds, as investors piled into the securities when it became obvious the economy was heading off a cliff.

In fact, yields on long-maturing bonds were trading below 3 percent and only 1-2 basis points on three-month T-bills, the lowest in decades, in December.

The proximate cause for the selling in Treasuries stems from expectations that the government will need to borrow about $2 trillion of debt this year to finance its rescue packages for the battered banking sector. Already, outstanding Treasury debt stood at $5.5 trillion at the end of September.

The 10-year treasury, for instance, has moved from around 2.00% to 2.62% at the end of last week. That big of a move is clearly noticeable in things such as 30-year fixed mortgages.

For a brief few days, the 30-year fixed could be had for under 5.00%- and as cheap as 4.80%. But as quickly as it was available, then it wasn’t- as ten year yields rose throughout the week-which pushed up mortgage rates.

What will happen to the housing market if the Fed and the Government cannot get mortgage rates to stay low?

I’m talking about if rates rise back to 6 or 7%.

Already, the housing market is grim. Part of the “plan” was to push down mortgage rates so that they were cheap enough to encourage home buying. The cheap rates also were to “save” some home buyers from foreclosure, as they could refinance into a much better rate at cheaper monthly terms.

But what will more cheap money actually accomplish?

There has never been a time when housing did well in a recession- and this time it will not be any different. The Fed is trying to counter people’s instincts: if you’re scared about losing your job, you’re not going to buy a house. It doesn’t matter what the mortgage amount.

Beware of the treasury complex. What was once seen as a source of stability, could become a destabilizing part of the market in the next few months.

Then the question becomes: where will all the money flow to?

Stocks?
Commodities?

Or cash?

Stay tuned.