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The Unpoppable Bond Bubble?

Leo Kolivakis's picture




 

Via Pension Pulse.

Colin Barr of Fortune/CNN reports on the unpoppable bond bubble:

Bond prices have been soaring since
U.S. job growth hit a wall in June. Yields on government bonds have
dropped to levels last seen in March 2009, when stocks were still
reeling from the post-Lehman Brothers bust. The 10-year Treasury yielded
2.6% Wednesday, down from 4% just four months ago.

With hopes of a V-shaped recovery fading, income-generating bonds look like a smart play. But Siegel writes in an op-ed
published Wednesday in the Wall Street Journal that "those who are now
crowding into bonds and bond funds are courting disaster."

 

Siegel,
author of "Stocks for the Long Run," notes that if interest rates
merely rise back to levels seen in April, recent buyers of 10-year
Treasury bonds will face capital losses more than three times the size
of the interest payments they stand to receive in a year.

 

He
likens the recent rush to bonds to the tech stock bubble that burst a
decade ago, comparing government bonds trading with a 1% yield to
Internet stocks that traded around 2000 at 100 times earnings. All it
would take to bust the bond market, Siegel suggests, is a sign that
current pessimism over the economic outlook is overdone.

 

Siegel's
right about the bond market walking a tightrope. But even those who
agree with Siegel concede that there is no sign that a gust of economic
recovery winds that might knock bond prices into free fall -- which
means the current, apparently unsustainable, bond rally could continue
for longer than anyone might like to say.

 

Stuart Schweitzer,
global markets strategist for JPMorgan Asset Management, says the bond
market is currently discounting a long period of subdued growth. That
may not change till policymakers led by Fed chief Ben Bernanke act to
eliminate the risk that falling prices will stall the U.S. deleveraging
cycle, he said.

 

"The odds will grow with time that policymakers will shift from fighting inflation to fighting unemployment," said Schweitzer.

 

But
after spending more than $1 trillion on bond purchases to keep money
flowing through the economy in 2009 and early this year, the Fed is
moving cautiously. It said last week that it would buy more Treasurys
with the proceeds of maturing mortgage bonds to keep the money supply
from contracting, but falling inflation expectations (see chart, above)
suggest it needs to do much more.

 

And with questions about taxes
and spending cuts unlikely to be settled till after the midterm
congressional elections in November, another period of uncertainty
likely lies ahead. In the meantime, bond yields could go still lower,
absent an unlikely Fed intervention or a surprisingly strong jobs
report next month.

 

Meanwhile, the
plunge of bond yields isn't just a U.S. phenomenon. Yields on Japanese
government bonds have dropped from already low levels to a minuscule 1%
on 10-year paper. The Japanese experience, where 10-year yields
haven't risen far above 2% since the late 1990s, shows a bond market
rout is no sure thing.

 

"Policymakers will find a way," says Schweitzer. Perhaps. But it will take time – and lots of it.

Back in January 2009, I asked whether there is a bubble in bonds and concluded:

If
deflation does develop, what seems like a bubble in bonds today, will
be nothing compared to what will happen when investors throw in the
towel and just buy bonds for the long-run.

The
threat of deflation, quantitative easing, and liability-driven
investments by global pensions is what's driving bond prices higher.
Moreover, some pensions are leveraging up on bonds
to meet their actuarial returns. And banks are borrowing at zero on the
short end, purchasing bonds to make the easy spread and trading in
higher yielding risk assets all around the world.

All these
factors are driving bond prices higher, and while it may look like a
bubble -- and likely is a bubble -- it's unlikely to pop anytime soon.
Inflation expectations are the key gauge for bond yields, and according
to Douglas Porter, deputy chief economist with BMO Nesbitt Burns Inc,
the drop in yields on Treasuries suggests the US economy is in for five to 10 years of slow growth:

“An
old rule of thumb is that real yields are a proxy for expected real
growth,” Mr. Porter said in a report to clients. A proxy for the real
yield (interest rates minus the inflation rate) is the 10-Year Treasury
Inflation Index note. The 10-year TIPS or U.S. Treasury
Inflation-Protected bonds are barely yielding 1 per cent, while the
five-year TIP yields are now flirting with zero.

 

“The sustained
drop in yields across the Treasury curve [for various bond durations]
in recent months has been driven as much by a sharp drop in real yields
as a descent in inflation expectations,” he said. The inflation rate
implied by the data over the next 10 years is 1.9 per cent, which is a
long way from deflation.

 

“The market seems to be saying that
real growth will remain quite weak for years, but outright deflation is
not a high probability … yet,” he said.

 

While bond prices
have soared driving yields down, the stock market has languished. The
record low level of interest rates should arguably also lead to an
expansion in the price-to-earnings multiples on stocks, but that has
not happened. Interest rates are low and earnings have been robust, but
given the miserable 10-year performance on the S&P 500, investors
continue to steer clear of stocks.

Stocks have languished and investors have been piling into bonds and corporate bonds, fearing deflation. But as foreigners continue to purchase US Treasuries,
and the yield curve flattens, global banks and global pensions will
have to start looking elsewhere as they search for yield.

It is
my contention that the liquidity tsunami will continue to drive all risk
assets higher. To be sure, we don't have the crazy leverage of the past
built in the financial system, but you'll see more than a few bubbles
forming in the next few years and they're all linked to the biggest
bubble of all, the US bond bubble.

Martin Roberge, Portfolio Strategist and Quantitative Analyst at Dundee Securities, wrote a comment, Gold: The time Has Come for a Bubble:

History
shows that gold and gold equities outperform under three scenarios;
heightened economic/financial risk, outright inflation and/or deflation.
The latter risk is spotted by our gold reflation gauge, which jumped
into positive territory lately. As such, we have become more comfortable
with golds’ fundamentals and are raising the gold group to an
overweight stance. The next push up, in our view, could mark the
beginning of a much-awaited price bubble in gold land.

Over the
near term, gold and gold equities are driven by what we call “economic
oxygen”, that is, expectations of economic reflation forces. This is
what our gold reflation gauge (Exhibit 1, 3rd panel) tries to capture by
monitoring movement in four variables, namely, US M2, the US$ index,
bond yields and gasoline prices. Contrary to the gold price advance seen
in H1/10, the recovery that started in August has a stronger
fundamental backdrop, with all four drivers listed above going in the
right direction for the bullion (Exhibit 2). The net result is a sharp
jump of our reflation gauge into positive territory, meaning that
investors are expecting/demanding monetary/fiscal rescue to alleviate
the deflation scares that have emerged lately.

As quants, we play
probabilities and odds now favour investing in gold and unloved
large-cap golds. Indeed, tables in Exhibit 1 show that when our gold
reflation gauge is above zero, the annualized monthly return for the
bullion is 16.1% (with the probability of rising at 71%) and for gold
equities vs. the market, it is 32.8% (with the probability of
outperforming the market at 65%).These statistics suggest that
conditions are in place for gold and gold equities to push into a higher
price range over the next 3 to 6 months.

Importantly, a higher
price range for large-cap gold equities would imply a break above
mutli-year price resistances. Indeed, Exhibit 3 shows that on the next
push up, the index of world gold equities would break above its 2009 and
1987 peaks relative to the world equity index. Interestingly, Exhibit 4
shows that relative forward earnings of the largest gold stocks (G, ABX
and NEM) have already surpassed their 2009 peak. Remember that relative
price and earnings strength are two powerful quant attributes.

Bottom line:
We are raising the gold group from a neutral to an overweight stance.
Lagging large-cap gold stocks are poised to break multi-year price
resistances over the next 3 to 6 months. The next push up, in our view,
could mark the beginning of a much-awaited price bubble in gold land.

In my last comment, I mentioned that several prominent hedge funds are placing big bets on gold.
The reasoning is that in an uncertain world, gold offers refuge against
the ravages of both inflation and deflation (especially physical gold).

Finally,
let me end this comment by going over another big bubble which I have
referred to in the past, the bubble in alternative investments fueled by global pensions funds and their insatiable appetite for "absolute returns".

Bloomberg reports that hedge fund icon Stanley Druckenmiller is quitting the business after three decades,
telling investors he’d been worn down by the stress of trying to
maintain one of the best trading records in the industry while managing
an “enormous amount of capital.”

Don Steinbrugge, chairman of Agecroft Partners,
talked about Stanley Druckenmiller's decision to shut his firm and end
his 30-year career with Carol Massar and Matt Miller on Bloomberg
Television's "Street Smart." Please click here
and listen carefully to Mr. Steinbrugge's comments on pensions' assets
flowing into hedge funds and how they are diluting returns and the skill
set of many hedge funds (I also embedded the interview below).

Will other hedge fund titans follow Mr.
Druckenmiller into retirement? I am sure they will but maybe they're
waiting to play one last bubble before the Mother of all bubbles pops.

 

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Thu, 08/19/2010 - 14:45 | 530994 SheepDog-One
SheepDog-One's picture

A bond bubble backed by dollars? Yea thats a real 'safe haven', LMFBO!!

Thu, 08/19/2010 - 16:30 | 531278 covert
covert's picture

why are we still playing with paper? why not use gold or silver?

Thu, 08/19/2010 - 13:08 | 530758 Ned Zeppelin
Ned Zeppelin's picture

"Fed's Bullard says treasury buying beyond that needed to keep balance sheet steady may be warranted if disinflation risk rises." RANSquawk today

well, there you go, Fed's messenger boy Bullard with what is really going on: QE 2.0 is here, folks.  This ain't QE Lite, or QE 1-1/2, this is the full monte.

 

Thu, 08/19/2010 - 13:13 | 530771 Spigot
Spigot's picture

QE forever till the debts are drowned in hyperinflationary cash...all better now.

Thu, 08/19/2010 - 12:54 | 530720 Muscletonian
Muscletonian's picture

Leo,

 

Hows the bottom fishing doing, still long from 1100, you got out with a small loss or keep riding it down the drain?

Thu, 08/19/2010 - 12:44 | 530696 Ripped Chunk
Ripped Chunk's picture

Shut the nitrous tank down, please!

Thu, 08/19/2010 - 13:11 | 530766 Spigot
Spigot's picture

Just calling em as I see em.

Thu, 08/19/2010 - 11:59 | 530578 Spigot
Spigot's picture

The assumption that the only thing that will drive the US bond market into the toilet is ...

/snip

But even those who agree with Siegel concede that there is no sign that a gust of economic recovery winds that might knock bond prices into free fall -- which means the current, apparently unsustainable, bond rally could continue for longer than anyone might like to say.

/snip

... is naive. Risk primia also can drive interst rates back up quite a lot, and I would suggest that repayment concerns (relative to currency valuation) will become the trigger that blows this sky high.

Foreign holders of USTs watching a devaluation of the US$ and artifically strangled interest rates will FLEE USTs and all other low yeilding bonds.

China just announced it will not use the US$ as a reserve currency, instead prefering the Euro (watch out Europe!), and is using its US$ holdings t buy other nation's bonds (Korea recently). And in IMO, China is conducting policy through financial means to seperate the US from its tight relationships with its "regional allies". Expect to see this as a continued weakening of overseas support for US policies as well as eroding finaicials and US$ in international transactions (to include falling US equities markets, etc).

Thu, 08/19/2010 - 11:40 | 530527 Grand Supercycle
Grand Supercycle's picture

The next leg down ...

http://stockmarket618.wordpress.com

Thu, 08/19/2010 - 11:31 | 530488 Problem Is
Problem Is's picture

Thanks for the info Leo... a novice learned something today...

Thu, 08/19/2010 - 11:24 | 530466 anony
anony's picture

"...about to pop"?

Absolutely not. 

There are few questions in life this unutterably simple that can be answered without reservations.

No, it is not about to pop.

 

 

Thu, 08/19/2010 - 09:06 | 530016 ZackAttack
ZackAttack's picture

Bond bubble started in 1980. Long bonds have outperformed every other asset class during that timeframe.

The bubble took 30 years to blow and it won't come unwound in an afternoon. Wait until it happens and catch a nice safe 50% out of the middle of the move.

When it does pop, I don't think shorting bonds is the trade; it's all the rate-sensitive derivatives.

Think about how much shit comes apart with, say, a 6% 10 year.

Thu, 08/19/2010 - 10:31 | 530232 Joeman34
Joeman34's picture

Well said.  Most people forget how well Treasuries have done relative to equities both over the long-term and recently.  For this reason, I think the day of reckoning may be closer at hand than many anticipate.  I can't remember where I saw this, but if 10-year rates rise only slightly, holders will be subject to unrealized losses greater than the expected interest payments they'll receive from the bonds.

 

The question is - as a small investor, how to play the eventual correction in Treasuries.  I don't like TBT or the other inverse ETFs due to leverage decay.  I don't have enough capital for complex derivative trades.  I'm thinking about getting more active in the Eurodollar futures and options market.  You [or anyone else] have any thoughts?

Thu, 08/19/2010 - 10:51 | 530296 bIlluminati
bIlluminati's picture

Long Canadian dollar, long resource stocks - but right now only the ones with low P/E. My gut feeling is that it's too soon for most of these except short Europe.

Thu, 08/19/2010 - 11:18 | 530442 Joeman34
Joeman34's picture

Interesting angle on the resource stocks.  Not so sure about Canadian dollar, however.  I've heard anectodally that their due for a property market correction similar to the one in the U.S.  If this happens, I think the dollar will once again be the best house in a bad [global] neighborhood.

 

Agreed on short Europe.  I am using leveraged ETFs for this trade [EUO, EFU] as I think the time horizon to realization is much shorter and therefore I'm not as worried about leverage decay.

Thu, 08/19/2010 - 08:12 | 529898 antidisestablis...
antidisestablishmentarianismishness's picture

Lots of people saw the housing bubble in '03.  Shorting bonds should be a lot like shorting housing stocks starting in '03. 

Thu, 08/19/2010 - 08:37 | 529938 Leo Kolivakis
Leo Kolivakis's picture

Excellent point, just because you see a bubble, doesn't mean it can't go on for a lot longer than you think. This bubble is engineered by the biggest hedge fund in the world, the Federal Reserve. All those big global macro hedge funds who tried massively shorting Treasuries got their asses handed to them in the last few years. Having said this, bonds are like stocks now, in a trading range. You can make money shorting bonds, but don't get greedy. Pick your spots carefully. There will be hiccups along the way.

Thu, 08/19/2010 - 06:44 | 529855 EscapeKey
EscapeKey's picture

"...policymakers will shift from fighting inflation to fighting unemployment," said Schweitzer.

One of the reasons hyperinflation kept going for so long in Germany was because TPTB realized monetary tightening would cause unemployment.

 

Thu, 08/19/2010 - 08:46 | 529958 Max Hunter
Max Hunter's picture

Germany 1920's was a totally different scenario. They had war reparation payments. As I understand it, that had a lot to do with the Wiemar inflation.

Thu, 08/19/2010 - 10:48 | 530280 bIlluminati
bIlluminati's picture

Germany 1923 had war reparations. We have Chinese interest rate payments. And, who is this "other" that's buying up U.S. Treasuries from the Chinese? ECB? Fed? Does the Fed just send checks to all the teachers, retirees, unemployed, and food-stampers until ...

Is $1.3 trillion per year in deficit spending greater than German war reparations? I'm going to take a wild guess and say yes.

Thu, 08/19/2010 - 05:36 | 529828 Young
Young's picture

It won't but, the question as always, when? I have a hard time seeing the media noticing this so close to the end.

Thu, 08/19/2010 - 05:24 | 529826 zhandax
zhandax's picture

The Chinese are dumping their trillion in T-bonds and our idiots have rigged the game so they can do so at a profit.  Collusion or coincidence?  Either way, anyone care to postulate how this ends well?

Thu, 08/19/2010 - 08:15 | 529900 antidisestablis...
antidisestablishmentarianismishness's picture

Life doesn't end well either.  Should we just kill ourselves right now?

Thu, 08/19/2010 - 08:42 | 529946 Max Hunter
Max Hunter's picture

That's all about perspective.. I'm thinking when I go, I'm gonna say wow.. this is nice.. Why was I worried about this.. LOL.. And i'm not religious.

Thu, 08/19/2010 - 05:23 | 529814 Young
Young's picture

Is it time to start asking ourselves whether equitities will fall, or, the bond bubble burst causing a rush of equity buying?

http://ftalphaville.ft.com/blog/2010/08/19/320151/the-bond-stock-decoupl...

Thu, 08/19/2010 - 02:35 | 529750 malek
malek's picture

...when investors throw in the towel and just buy bonds for the long-run.

Well, I as an investor will never buy a single bond before this bubble pops!

Thu, 08/19/2010 - 02:25 | 529745 Hedge Jobs
Hedge Jobs's picture

Siegel, author of "Stocks for the Long Run,"

anyone who writes a book with the above title should be ignored.

"His 1994 book Stocks for the Long Run sealed the conventional wisdom that most of us should be in the stock market." He was right for 5 years and wrong for 10!

this guy is a perpetrator of the Ponzi

Thu, 08/19/2010 - 00:48 | 529704 AUD
AUD's picture

Read some Doug Noland, www.prudentbear.com, he's got the best handle on credit. Some snippets from last week:

"Tuesday’s announcement from the Federal Open Market Committee (FOMC) further emboldened a highly-speculative fixed-income marketplace."

"But the real show was provided – once again - in fixed income.  Prices continued their melt-up – yield meltdown – with Bubble Dynamics becoming only more conspicuous each passing week.  And I know that most dismiss the Bubble thesis and view prices as reflecting poor economic prospects and the deflationary backdrop.  I would respond that the environment remains extraordinarily conducive to Bubble expansion."

"Today, extreme activist fiscal and monetary policies inflate the Global Government Finance Bubble.  After the 2008 fiasco, I have a difficult time comprehending how analysts can remain dismissive of Bubble risks.  And with an increasingly conspicuous Bubble at the heart of our monetary system, our central bank should not be reinforcing the market perception that the Fed is there to backstop the markets and economic recovery with open-ended Treasury purchases."

Thu, 08/19/2010 - 00:11 | 529670 anonnn
anonnn's picture

more Pres. haiku:

Great finger-wagger.

constitutional scholar.

dear Shirley Sherrod.

 

 

Wed, 08/18/2010 - 23:15 | 529607 Rob Jones
Rob Jones's picture

Tsunamis come charging in, do a huge amount of damage, and then head back out to sea.

Thu, 08/19/2010 - 00:05 | 529666 anonnn
anonnn's picture

Presidential haiku:

Tsunamis come charging in

do a huge amount of damage

and then head back out to sea.

Wed, 08/18/2010 - 23:49 | 529648 TBT or not TBT
TBT or not TBT's picture

Mixed metaphor alert:    After a tsunami strikes, you can't determine for sure which of the victims was swimming naked.     Just saying.

Wed, 08/18/2010 - 23:26 | 529624 Rob Jones
Rob Jones's picture

But they do create lots of bubbles.

Wed, 08/18/2010 - 23:11 | 529602 traderjoe
traderjoe's picture

Leo, if the bond bubble pops, what happens to the stock market? Can't be good for the Chinese solar stocks?

Thu, 08/19/2010 - 00:21 | 529677 Young
Young's picture

It's great for stocks if they cause the bond bubble to burst, i.e. the "herd" moves back to stocks.

Thu, 08/19/2010 - 00:41 | 529694 pitz
pitz's picture

Great for large-caps that have productive physical assets.  Terrible for small caps and firms that require on-going financing to be viable.

 

 

Thu, 08/19/2010 - 04:15 | 529803 Young
Young's picture

I should add to my post that it's great for stocks if the money moves into stocks from bonds. Considering your post pitz, neither the administration nor the media gives a shit about small caps/small businesses. The administration would rather bragg about adding jobs in the public sector which guarantees absolutely zero/zilch growth but higher taxes... Welcome to the Soviet States of America. Meanwhile the small businesses are dying, but hey, let's all work for "the federation", sure that will work out fine... Or not.

Wed, 08/18/2010 - 23:23 | 529618 Leo Kolivakis
Leo Kolivakis's picture

Read my comment carefully, it won't pop anytime soon. In the meantime, enjoy all those other bubbles forming as hedge funds look to justify their 2 & 20 fee structure.

Thu, 08/19/2010 - 13:29 | 530812 SheepDog-One
SheepDog-One's picture

'Bond bubble wont pop anytime soon' oh well until at least tomorrow when Israel take out Buhshear, and retaliations against US commence. All is well, until it suddenly and tragically and 'UNEXPECTEDLY' of course no longer is.

Wed, 08/18/2010 - 23:59 | 529660 whatsinaname
whatsinaname's picture

anytime soon could be tomorrow ?

as if you can really time the bond market..

Wed, 08/18/2010 - 22:45 | 529578 RockyRacoon
RockyRacoon's picture

...in an uncertain world, gold offers refuge against the ravages of both inflation and deflation (especially physical gold).

Well, there ya have it.  Bonds?  What bonds.  I don't need no stinkin' bonds.

Wed, 08/18/2010 - 22:44 | 529576 Mitchman
Mitchman's picture

The Bond Bubble is the Mother of All Bubbles.

Thu, 08/19/2010 - 07:25 | 529873 Moonrajah
Moonrajah's picture

So what do we call those inflating it? Motherbubblers?

Thu, 08/19/2010 - 09:56 | 530135 Mitchman
Mitchman's picture

Good one!

Wed, 08/18/2010 - 23:53 | 529652 TBT or not TBT
TBT or not TBT's picture

And government/CB activity is then the godmother, godfather, obstetrician, gynecologist, wing woman, bridesmade, natural father, father, and health insurance provider of the Mother.

Wed, 08/18/2010 - 22:47 | 529575 Mercury
Mercury's picture

Siegel's right about the bond market walking a tightrope. But even those who agree with Siegel concede that there is no sign that a gust of economic recovery winds that might knock bond prices into free fall -- which means the current, apparently unsustainable, bond rally could continue for longer than anyone might like to say.

Right, so either we stay in a depression or a rise in rates accompanying any inklings of a recovery crashs the bond market and we go into a total economic collapse.

Please make a note of it.

Wed, 08/18/2010 - 22:34 | 529556 Hansel
Hansel's picture

... it's unlikely to pop anytime soon...

Subprime is contained.

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