That crazy, crazy bond market: a call for sub-3% long bonds

All of a sudden, the bubbleheads seem to have caught on that the recession is worldwide and that this means lower demand for commodities. With the dollar rallying to boot, the (bad) idea of buying copper or oil as a dollar hedge is gone.

I predict that the dollar rally will strengthen the compression of Treasury yields at all ends of the curb, as the market perceives a lower currency risk. This is a sign of deflation: an increasing preference for cash. With the banking system on the verge of a collapse worse than the ’30s, people will have no choice but to buy Treasuries. These promises of an insolvent and unrepentant debtor are safer than cash in the bank (because its not really in the bank!).

This flight to safety will send short-term yields back under 1% (as they were in March), and traders will move out the yield curve to get ahead of the compression, driving long bonds to historic lows, likely well under 3%.

Talk about a conundrum.  The nation is already on the hook for $50+ trillion and is on track to run trillion dollar deficits to pay for wars, the Fannie and Freddie bailouts, baby boomers’ retirement and medical bills, growing unemployment payments, and the new New Deal that is being drawn up and fought over (Boone Pickens wants a piece). It is safe to say that the US will never have a balanced budget again and will default on its entitlement promises and outstanding loans within a generation.

In more than a few ways the coming depression is a gift for the government, not the least of which is the ability to keep the game going a bit longer by creating demand for its debt at ridiculously low rates. What choice do investors have to keep their money safe, when banks are broke, corporations are going broke, commodities are collapsing and real estate is toast, all over the world? (I would suggest gold, but even that should go still lower in this panic, as weaker hands are forced to sell anything with a bid).

But the 30-year T-bond under 3 percent? Preposterous, you say! Bond traders are the smartest, most wizened bunch out there. They don’t let just any bloke into that club. They know the long bond is all risk for no reward. But look at these startling illustrations of what the market has done at the past two turning points in the generation-long bond cycle: the 1940s and early 1980s:

Here first is a shot of yields as they made their last bottom, in the ’40s:

And here is CPI hitting double digits at the same time:

Next, yields topped out a quarter century ago like this:

Note how by 1982, CPI was 6% and dropping fast, but yields remained over 12%.  And how do you explain that second peak over 13% in 1984, when CPI had merely ticked up from under 3% to just over 4% ?

So it may seem crazy, but it is entirely possible (and given the banking crisis, likely) that long Treasury yields will fall to 60 year records in the face of horrible fundamentals. But once they get there, I expect them to turn up and keep going, as the government starts to default by Fed printing.

To all those who feel that the US debt just DESERVES to be shorted, I say wait. It will get more deserving.

About these ads

2 thoughts on “That crazy, crazy bond market: a call for sub-3% long bonds

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Connecting to %s