“You have talked about attempting to profit from the bursting of the bond bubble, once it starts happening. I wondered how exactly you planned to profit from this - what type of instruments will you be buying/shorting?”
Eoin Treacy's view Thank you for this question which may be of interest to subscribers. Please also see David's Comments on this subject in Comment of the Day on Wednesday. Shorting a market which is in a mania is a dangerous practice until there is clear evidence that it has burst. The adage attributed to Keynes that the market can stay irrational longer than you can stay liquid is particularly apt in this scenario.
Since the majority of investors in Treasuries approach the market from a total return perspective then the best way to monitor the market, in my opinion, is from that perspective. The Merrill Lynch 10yr+ Futures Total Return Index remains in a consistent uptrend and a sustained move below 1660 would be required to question medium-term scope for further upside. When this eventually occurs we will have incontrovertible evidence that the more than 30-year bull market has ended but until then, the upside should be given the benefit of the doubt.
As David mentioned on Wednesday, when the market eventually tops out, buying out-of-the-money put options are likely to be the best vehicle to profit from this move. Contagion across asset classes and elevated volatility are a virtual certainty in the early stages of a significant rise in yields. Subsequently, short-dated paper, property and equities should all outperform bonds.