Monday, November 03, 2008

Treasury Yield Forecast: Ginormous

There is no longer any doubt that next year's federal deficit will be ginormous:

The U.S. Treasury more than tripled its planned debt sales for this quarter to help finance a 2009 budget deficit that bond dealers advising the department estimate may swell to almost $1 trillion.

The worsening credit crisis and sluggish economy are straining the country's finances and will leave the winner of tomorrow's U.S. presidential election facing the worst budget shortfall on record next year. The Treasury is scheduled to announce in two days plans to expand debt sales to fund the gap.

I first predicted a steeper yield curve last month when I assessed the long-term impact of moving Fannie and Freddie debt onto the U.S. government's balance sheet. This was even before the bailout ballooned the coming supply of Treasuries:

Even as Ben S. Bernanke cuts borrowing costs to 50-year lows, taxpayers will likely be paying ever increasing interest rates on U.S. debt.

The next president may find foreign investors, the biggest creditors to the U.S., unable to absorb a growing supply of Treasury bonds as the financial crisis prompts nations to invest in their own banks and currencies. That would drive up yields just as a widening budget deficit pushes borrowing needs to a record $2 trillion, according to estimates by Goldman Sachs Group Inc. and Wrightson ICAP LLC.

My play: I'm not buying long-term T-bonds until yields are well over 15%. I'm not a conservative investor, but new-issue bonds with double-digit coupons are a once in a lifetime event. Unrealistic you say? Just wait until early 2010. The cash flow from these ginormous yielding bonds will fund my purchases of radically cheap equities by then.