Bonds have been in a bull market for over 30 years, culminating with multiple Quantitative Easing efforts by the Fed to suppress interest rates at all-time lows. The big question since 2009 has been: when and how quickly will rates rise? It’s a concern because it will have a big impact on bond funds since bond prices fall when interest rates rise. A LOT of people have tried to call the actual top in bonds (bottom in rates) and I’ve definitely noticed a lot of bearish predictions on bonds lately in the financial media following the quick increase in rates over the past 6 weeks (the 10-year Treasury yield has risen from 1.62% to approximately 2.20%, and the 30-year Treasury yield has risen from 2.82% to approximately 3.35%).
This all stemmed from Ben Bernanke making a few comments following the last FOMC meeting on May 1st that they could either increase or decrease the amount of bond purchases depending on economic data. Investors assumed he was hinting that the Fed will begin to cut back in the near future, even though he didn’t explicitly state it, and now we have predictions that the 10-year will rise to 3% by year-end without the Fed’s support.
I had written a pretty lengthy analysis of why I disagree but then I realized you probably don’t care about all the details. So, to save you some time, here’s the bullet point breakdown:
- Bernanke’s M.O. is inflation. Always has been, always will be. He’s a student of the Great Depression and his number priority is avoiding deflation (as it probably should be given our fractional reserve banking system)
- Inflation in the US is falling back toward 1%, nowhere near the Fed’s 2% – 2.5% target
- Inflation in Europe will probably turn negative this year
- Consumer credit is still contracting
- It’s a nightmare to get a loan/mortgage from the banks
- China is still slowing
- Commodity prices are down almost entirely across the board in 2013 (oil and nat gas are basically the only two that are up, and oil’s gain have basically come in the last 3 weeks)
- Other Central Banks are increasing their Quantitative Easing efforts at a far greater pace than the US
- Just about every decision the governments of the Western nations have made has been deflationary (e.g. raising taxes)
- There is no benefit to cutting back too soon – it could prove very costly
The Fed does not want rates to rise yet. With inflation falling, I think we’re more likely to see the Fed increase the amount of Quantitative Easing than decrease. I’m also not convinced that we’ve seen the low in nominal yields just yet…
The next FOMC announcement is this Wednesday. I will be very surprised if Bernanke mentions anything about cutting back. We’ll see…
-Nick