by ilene - September 7th, 2010 3:42 pm
Courtesy of The Pragmatic Capitalist
The bond bubble theorists aren’t going to be happy about this report from RAB Capital. Their analysts believe there is room for a “massive decline” in government bond
“Interest rates cannot go up meaningfully for a very long time” in either country, the report said. U.S. Treasury yields have yet to fall far enough relative to the Fed’s target rate for loans between banks to reflect this prospect, he wrote. The same holds true for yields on U.K. gilts by comparison with the Bank of England’s base rate, in his view.
The 20-year Treasury yield ended last week at 3.49 percent after declining 1.2 percentage points from this year’s high, set on April 5. Twenty-year gilts yielded 3.91 percent after falling 0.83 point from a Feb. 19 peak. The gaps between the yields and benchmark
rates— 3.24 points and 3.41 points, respectively — were still close to 40-year highs, according to the report.
“Further purchases of bonds by central banks can only accelerate this inevitable adjustment” in yields, Joshi wrote, adding that the bull market in fixed-income securities “is far from over.”
The Fed may have to buy more debt to head off deflation, according to Joshi, who described this so-called quantitative easing as “the greatest pawn-broking scheme” ever implemented. Fed policy makers decided last month to keep the central bank’s securities holdings at $2.05 trillion by reinvesting proceeds from maturing mortgage-backed bonds into Treasuries.
It’s an interesting chart and analysis, however, the one thing I would point out is that rates tend to converge (1:1) when the Fed is fighting off an inflation threat. The periods shown on the above chart shows when the Fed raised rates substantially and inverted the yield curve. In other words, the bond market was less concerned with inflation than the Fed was. Perhaps more importantly, however, the economy was smoking hot when rates converged. While I don’t disagree that rates are likely to remain low for some time, the implication that rates could converge appears a bit misleading. 10 year rates in Japan are sub 1% after 20 year of malaise while the overnight rate remains near zero. Are we headed there? I am not that…
by ilene - August 19th, 2010 4:47 pm
Courtesy of The Pragmatic Capitalist
There is increasing chatter of the great “bond bubble” as U.S. Treasury bonds surge ever higher and deflation fears rise. This is just one more myth that has persisted in recent years (decades really) due to mass misconception of the way the bond market actually operates and this propensity to label everything as a “bubble”.
Before we dive into the real meat of the argument it’s important that we define what a market “bubble” is. A “bubble” occurs when market forces combine to generate a highly unstable position. This results in the system entering an extreme disequilibrium and ultimately failure. The causes of this “bubble” (or extreme disequilibrium) can be many – though primarily psychological any number of exogenous factors can contribute to the instability of the system (government policy for example). The psychological aspect of a bubble is well explained by analysts at BNP Paribas:
“When interacting agents are playing in a hierarchical network structure very specific emerging patterns arise. Let us clarify this with an example. After a concert the audience expresses its appreciation with applause. In the beginning, everybody is handclapping according to their own rhythm. The sound is like random noise. There is no imminence of collective behavior. This can be compared to financial markets operating in a steady-state where prices follow a random walk. All of a sudden something curious happens. All randomness disappears; the audience organizes itself in a synchronized regular beat, each pair of hands is clapping in unison. There is no master of ceremony at play. This collective behaviour emanates endogenously. It is a pattern arising from the underlying interactions. This can be compared to a crash. There is a steady build-up of tension in the system (like with an earthquake or a sand pile) and without any exogenous trigger a massive failure of the system occurs. There is no need for big news events for a crash to happen.
Financial markets can be classified as open, non-linear and complex systems. They also exhibit emanating patterns as a result of which the “invisible hand” can be very shaky. More then 40 years ago Benoit Mandelbrot described the fractal structure of cotton prices and the emanating properties of fat tails and volatility clustering and Hyman Minsky proposed a theory for endogenous speculative bubble formation.
by ilene - August 18th, 2010 10:08 pm
The ‘Treasury Bonds are a Bubble" meme has been going around and building intensity for months now, but we’ve finally seen the definitive article written on the subject in the Wall Street Journal.
Jeremy Siegel and Jeremy Schwartz frame the story in a context that the investor class will truly understand – they compare it to the dot com bubble. I had front row seats for that show as a young stockbroker ten years ago and, like anyone else that was there, I have injuries so visceral that I can actually sense when rain is coming.
Of particular importance is their comparison of tech stocks then with TIPS now…
We believe what is happening today is the flip side of what happened in 2000. Just as investors were too enthusiastic then about the growth prospects in the economy, many investors today are far too pessimistic.
The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout.
The rush into TIPS has felt mind-boggling to me, in spite of the fact that this trade has "continued to work". With the Professor in agreement, I feel (only slightly) better about my reluctance to participate.
Meanwhile, The Boss has been making the media rounds talking about the bond bubble story all week, on MSNBC and Fast Money last night, on Bloomberg Radio this morning. This long-simmering story is finally getting some real attention.
Felix Salmon and Vince Fernando have had a highly important back-and-forth on what exactly the TIPS Spread is pricing in and Eddie Elfenbein picked up on the fact that JNJ was able to price a 10-year bond with a yield under 3% while it’s common stock pays a 3.6% dividend yield.
The disgust for the growth prospects of equities is palpable as money flies out of stocks and piles into bonds of every stripe. Here’s the WSJ on these inflow/outflow stats:
Investors, disenchanted with the stock market, have been pouring money into bond funds, and Treasury bonds have been among their favorites. The Investment Company Institute reports that from January 2008 through June 2010, outflows from equity funds
by ilene - August 11th, 2010 2:33 pm
Courtesy of Tyler Durden
Nassim Taleb is out making waves once again, this time at the Discovery Invest Leadership Summit in Johannesburg today, where he said he was “betting on the collapse of government bonds” and that investors should avoid stocks. To be sure this is not a new position for Nassim, who in February had the same message, when he said that "every single human being" should be short U.S. treasuries. Indeed since then bonds have gone up in a straight line as the bond bubble has grown to record levels, and with the ongoing help of the Fed, is it any wonder. The only question is when will this last bubble also pop.
More from Bloomberg:
“I’m very pessimistic,” he said at the . “By staying in cash or hedging against inflation, you won’t regret it in two years.”
Treasuries have rallied amid speculation the global economic recovery is faltering, driving yields on two-year notes to a record low of 0.4892 percent today. The Federal Reserve yesterday reversed plans to exit from monetary stimulus and decided to keep its bond holdings level to support an economic recovery it described as weaker than anticipated. The Standard & Poor’s 500 Index retreated 16 percent between April 23 and July 2, the biggest slump during the bull market.
The financial system is riskier that it was than before the 2008 crisis that led the U.S. economy to the worst contraction since the Great Depression, Taleb said.
Will the Black Swan author be correct? Perhaps (and given enough time, certainly), although as virtually everyone is expecting a dire outcome in both the public and private sector, courtesy of the untenable balance sheet, the surprise will most certainly have to come from some other place. And with even The Atlantic now posting cover stories on the Iran war spark, it is increasingly less likely that geopolitics will be the issue. Is every possible dire outcome priced in? If so, Taleb should focus his formidable intellect on answering just what the market is missing.
by ilene - July 7th, 2010 12:16 pm
Courtesy of Rom Badilla of Bondsquawk.com
Interest rates have rallied tremendously in recent months as concerns of an economic slowdown and the potential for a double dip weigh on the minds of both Wall Street and Main Street. Since early April, which marks the recent high in rates, the long-end of the curve has rallied significantly. The yield on the 10-Year U.S. Treasury has declined more than 100 basis points to 2.97 percent during that time frame.
That type of change usually takes many months, if not years, to accomplish. The average implied volatility of both interest rate swaptions and options on Treasuries over the last 10 years is around 100-120 basis points on an annualized basis. Hence, the move to where we are now is quite significant.
Admittedly, part of the decline is attributed to a flight to quality due to fears of contagion from Greece and the European debt crisis. However, the last leg of the drop in yields was due to signs of a slowing economy and declining price pressures. If it were a continuation of the flight-to-quality trade, we would have seen the dollar appreciate as was the case earlier when the Euro approached parity as sovereign risk escalated. Lately with the recent string of weak domestic economic data, the dollar has declined 1.7 percent from June 21 while the 10-Year rallied 26 basis points and pushed below 3 percent.
If there’s any argument that there is a bond bubble, keep in mind that there needs to be an imbalance, i.e. a shift in outlook toward lower rates. Basically, the majority of the world needs to be on one side of the boat, where tipping over is a possibility and the imbalance is ultimately rectified. Right now, we are far from that.
According to Bloomberg’s economic and interest rate survey, market participants still expect higher rates to materialize with the Federal Reserve raising rates in early 2011. In additions, forecasters expect the 10-Year to increase 40 basis points to 3.37 percent by the end of the Third Quarter.
Rate hawks and bond vigilantes are still advocating for higher rates as the U.S. grapples with both perceived higher inflationary expectations fueled by future economic growth and higher fiscal deficits. To be honest, after packing on the calories by downing countless hotdogs and…