Guggenheim Partners: Treasurys Are a ‘Ponzi Market’

Jun 13, 2013

Guggenheim Partners: Treasurys Are a ‘Ponzi Market’

By Steven Russolillo

Scott Minerd, global chief investment officer at Guggenheim Partner, minces few words in his characterization of how the Fed’s easy-money policies have distorted the Treasury market over the years.

“The U.S. Treasurys market could now be described as a Ponzi market,” Minerd told clients Wednesday evening.A Ponzi scheme is a con that requires an ever-increasing number of new participants to pay off earlier investors. The scheme can grow exponentially, as in the case of Bernie Madoff’s Ponzi operation. But when people start withdrawing money, it can collapse very quickly.

Clearly, the Treasury market doesn’t resemble a classic Ponzi scheme. Still, Minerd’s points about the risks and distortions in the Treasurys market are well taken in this day and age.

The Fed’s $85 billion monthly bond-buying program, Minerd says, has given investors a false sense of security and confidence about the bond market.  When investors ignore fundamentals in the Treasurys market and buy anyway, based solely on the notion that they’ll be able to profit in the future because the Fed will keep buying and boosting prices, there are bigger issues to worry about, he says.

From Minerd’s note:

The U.S. Treasuries market could now be described as a Ponzi market. The only reason investors would buy Treasuries today is that they expect the Federal Reserve will buy them at higher prices in the future. This reasoning will come unstuck, however, once the Fed curtails its asset purchase program. We do not know when the Fed will taper QE, but the longer its expansionary policy continues, the more volatility-inducing pressure will build. That means stock and bond markets appear to be in for a rough ride over the next six months or so.

One reason behind Minerd’s mindset is the breakdown in correlation behind the inflation-adjusted 10-year Treasury yield and the Thomson Reuters/University of Michigan consumer sentiment index, he says. As the chart shows, the two historically moved in tandem, but the correlation broke down in the fourth quarter of 2011 due to the Fed’s quantitative easing programs.

“The yield on 10-year Treasuries would be roughly 150 basis points higher than it is today if the market was not being distorted by Ponzi (uneconomic) buying,” he says.

Minerd isn’t the first market watcher to make the Ponzi analogy. In October 2010, Pimco’s Bill Gross called QE2 a Ponzi scheme and said its arrival would mark the end of the rally for U.S. Treasurys.

That call proved to be magnificently wrong throughout the rest of 2010, 2011, 2012 and for the bulk of this year as well. But in May government bond prices suffered their seventh worst month for since 1985. Gross also went on record last month saying the secular 30-year bull market in bonds likely ended in April.

Ponzi, or not, there are clear distortions in the Treasurys market now that could make for some ugly unwinding in the weeks and months ahead.