ETF Expert

Surprisingly, and perhaps even shockingly, investing in Treasury Bond ETFs has been profitable in 2010. Very few folks would have “thunk it.”

Consider all of the forces conspiring against treasury debt success. The U.S government’s triple-A rating is being “questioned.” Treasury yields are decidedly unattractive when compared to alternatives. We’re issuing new debt in record-breaking fashion to pay for an ever-expanding deficit. Worse yet, both China and Japan have been net “sellers” for the last 3 months.

And yet… check out the gains:

Before popping the champagne cork, however, one better look to the brewing trade tensions between the U.S. and China. We’re insisting that the Chinese let the currency markets determine the value of the yuan relative to the U.S. dollar.

Granted, it might be nice if the Chinese let their yuan appreciate against the dollar, as well as let the yuan appreciate against neighboring Asian currencies. Yet I find it sadly ironic that the U.S. government believes it has any power to force China’s currency hand.

In fact, the more we have seen fit to tell China what to do, the more it sees fit to sell its U.S. Treasury debt. January marked the 3rd consecutive month in which the mainland has scaled back its holdings of U.S treasury bonds. Japan also lightened up on U.S. treasury bonds.

Indeed, a cheaper U.S. dollar would make American products less expensive for the Chinese consumer; ostensibly, it might also give its neighboring Asian partners an opportunity to export more goods to American consumers.

Nevertheless, if the U.S. escalates its “war of words” over China’s currency policy, foreign holdings of U.S. treasury securities could decrease substantially. Without Chinese buyers of U.S. treasury debt, the U.S. cannot finance its “ambitious” deficit spending.

China currently owns as much as 25% of all foreign-owned U.S. treasury debt. It follows that neither Japan nor the oil exporting countries will be able to fill the gap that China fills… should China markedly decrease its stake.

There are those economists who believe that the slow selling of treasury debt by China and Japan merely reflects “normalization” after the credit crisis; that is, things are getting back to the way they ought to be, now that investors do not need to flock to the perceived safer haven of U.S. treasury bonds.

However, if  the bond rating agencies keep warning the U.S. about its AAA status… if foreign demand from the Far East for U.S. Treasury debt weakens… then the interest rates that the U.S government pays is going to rise dramatically. How long would the Federal Reserve be able to keep rates relatively subdued if China “dumped” its holdings rather than “trimmed” them slowly?

I’m not waiting to find out. I continue to trim/reduce/lower exposure to intermediate and long-term U.S. treasuries. What’s more, most Treasury Bond ETFs are now below 200-Day moving averages, a sign that they are already in a technical downtrend.

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