Are Treasurys mispriced?

The dominant view among liberals is that the low, low yields on Treasurys reflect the market’s serene confidence that America will make good on its debts. But some of the investors and economists I spoke to while reporting out my piece on the debt ceiling disagreed.

PIMCO’s Bill Gross and former-Reagan budget director David Stockman both think Treasurys look safer than they are because the central bank, as part of quantitative easing, is buying up so many of them. “There’s a terrible mispricing of the potential negative aspects of this debt situation,” Gross says. “When the Federal Reserve gets out of the Treasury market on June 30th, the question becomes who will buy them at these yields, and I don’t know who would.” Gross, incidentally, has put his money where his mouth is by making a big and very public play against Treasurys.

But he’s not alone. Stockman, for instance, is even blunter. “It’s a hothouse, an artificially rigged market,” he says. And once the Fed exits, “there’s nothing to keep it from collapsing.” Stockman worries that people are underestimating the capacity of investors to wake up to the mispricing and exploit it. “It shouldn’t be underestimated that once the smart investors figured out that the subprime and housing mortgage market was busted, they went after it hammer and tong brought about a dramatic change in pricing in 12 months. If they start that on Treasurys, you’ll have a different world a year from now.”

The Federal Reserve disagrees with them. Otherwise, they wouldn’t be exiting the market in June. They point to the end of the first round of quantitative easing, when they backed out of the market and private demand rushed into replace their purchasing, keeping yields low. They think that’ll happen this time, too. We’ll know who’s right soon enough.