Three Little Pins and Their Quest for a Treasury Bond Bubble

As we've discussed previously, there is a bubble in the US Treasury bond market. And as we discussed in Ka-Poom Theory, bubbles always find black swan events -- "pins" to pop them and cause a market panic. As John Mills, a historian of market panics, said, "Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works."

What will be the pin that pops the Treasury bubble, causing a panic that reveals its true value? While it would be futile to try to predict an outlier event, understanding areas where it may be more likely can help us identify potential triggers for what will cause a market panic, so that we can more easily recognize it when it occurs.

There are three pins I think are most likely:

1. Mass monetization announcement. We are seeing appetite for Treasury bonds decline. If the Fed either significantly begins to monetize the debt (i.e. print money to pay it off) or announces it will do so, this could trigger an exit from Treasuries.

2. Military threat. 9/11 was a black swan event that punctured the dot com bubble significantly. As there is still a significant amount of conflict and political tension in the world, a military event triggering a mass exodus out of Treasuries seems possible -- particularly when one considers that some of the largest holders of Treasury bonds are foreign central banks with economic interests that run contrary to those of the United States.

3. "Legislation". The Federal Reserve can modify its charter, Congress can assign more authority to it, and central banks can come into new agreements amongst themselves. For instance, a regional currency which national currencies would be re-valued against is becoming a more commonly voiced idea in many parts of the world. If there is a monetary agreement of sorts, it will likely have the impact of devaluing the US dollar, as a way of compensating foreign US Treasury bond holders.

As a dollar trader, I'll be keeping an eye on potential pins for the Treasury bubble, as well as price charts that can show when momentum has turned. Though when the bubble will pop, as well as how bit it will get before doing so, remain unclear.

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