For All The Bond Bears Banking On Inflation

Tyler Durden's picture

It's common sense - everyone knows that interest rates are going to rise (how can they fall any lower?) Inflation will come back (because the Fed said so), economic growth will flourish (because the Fed said so), and longer-term bond yields will surge in a bond-bull-destroying renaissance proving stock market speculators right all along. Except that isn't what history shows us... When a central bank dominates the domestic bond market, all bets are off (whether economically rational or not). When a sovereign simply cannot afford higher interest rates, all bets are off (no matter what your economic textbook says).


Source: JPMorgan


Simply put - this is not your father's bond market anymore.

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knukles's picture

We be in the Japanese model!

Here's a bit of disconcerting math...
If Long rates drop from 4% to 3%, that's a 25% decline in yields.  So if you had a $1,000,000 (for math simplicity) invested at 4% you earn $40k while at 3%, $30K.  Simple, right?
So, if you had that $1,000,000 invested in stocks that were up 25% while them rates fell, you'd think that you could get the 40K by buying into the now yielding 3% bonds, right?
Wrong.   $1,250,000 earning 3% only'll getcha $37,500

The alternative asset would have had to rise by 33%, not 25% to get the same level of income, the $40k

Which, the math calc is right there.
You simply figure what increase in rates would be necessary to get back to the original level... or 3% to 4% is a 33% increase, so the stawks would have had to go up 33% to generate the same $40k

Say it ain't so, Joe.

Bond math 101

And then, the cap gains of 33% is taxable, so the stawks gots to go up more than that!

Getchur income while you can!

Black Forest's picture

Everything is going to be alright. Trust me.

Clint Liquor's picture

"All bets are off"

Sounds great! Please tell me how I can take all my 'bets off'  in a fiat currency world.


Newsboy's picture

These T-bills could go from "valueless" to "worthless" in a heartbeat.


Stackers's picture

until they lose control.....


Which will come in the form of an international run on the dollar and US treasuries. something the Fed can not stop.

Poundsand's picture

I think they'll just soak them up.  In today's world it's just digital anyway.  Who's to stop them?  ....   crickets

The entire paradigm in different


Sudden Debt's picture

Indeed it is. Check this:

Cash in the wallet is going exinct so nobody really sees the volume and prices just keep going up as a number.

But in the end, inflation destroys everything and income isn't following. If income would go up also, the economy could have been saved.

Thomas's picture

I believe that the rock and the hard place will become proximate. Can't say exactly how it will work out, but I have faith--apparently a Noah Smith catechism--that this kind of bullshit Carnot cycle doesn't ever work sustainably.

DeadFred's picture

When they lose control it will be corporate bonds that go first. HYG is not where I'd look for yield now. They'll hold the line on treasuries as long as they can

knukles's picture

Si.  Spreads will gap out as perceptions of risk increase.

andrewp111's picture

IMHO, the only think that can make the Fed lose control is oil. They can't print oil, and when the Caliphate takes Baghdad and moves on the oil fields, the price will blow out to the moon.

cpnscarlet's picture

Do we really need to say it?

Gold, biatch.

El Vaquero's picture

Except Japan is a culturally rigid island nation that had the rest of the world to lean on because it actually makes (made?) shit.   It didn't flood the rest of the world with Yen either, at least not compared to what we've done with the dollar.

socalbeach's picture

Your math is almost exactly right for a 30 year zero coupon bond.  A zero coupon bond means you get paid at the end of the term, so that you pay less at the beginning and the interest compounds.

The shorter the term of the bond, the less interest rate changes affect the bond price because the total interest you receive is less as a % of the bond price.

The exact formula is:

Bond price change = (Y1/Y2)Y where Y1 is the initial yield (expressed as 1.04), Y2 is the final yield (1.03), and Y is the number of years the bond matures.

So if Y = 20 (20 year bond), the formula gives 1.21 or a 21% change in bond price if the interest rate goes from 4% to 3%.  If Y=30, you get a 33.6% change in the bond price, etc.


Buying bonds might make sense if you can borrow at near 0%, use leverage, or are investing OPM and you get paid a % of the profits.  I think I'll pass since dollars are depreciating faster than the current 3.5% yield on 30 year Treasuries.  If 30 year bond yields were to go from 3.5% to say 5%, you'd lose 35% (0.65 = (1.035/1.05)30) of your money.

knukles's picture

I wasn't addressing price sensitivity to changes in rates (duration, lr first derivative) or the error of estimate (convexity or second derivative).  I was addressing only spendable income and the amount of funds necessary to invest at differing yield levels to maintain such opposite alternative asset price changes.

But to your point, if rates rise or fall, yes the greater duration the greater price change, etc., correct.

socalbeach's picture

Your post was a good one, I was just elaborating for the benefit of others..

buzzsaw99's picture

incontrovertible fact that rates cannot rise significantly. even if it were not so that would not prove stock speculators correct because they are absolutely banking on low rates forever. bondzilla (if such a thing existed) would destroy them as well so imo the author is mistaken as to their thesis.

disabledvet's picture

Stock speculators are betting on the TED spread. Interestingly the biggest sell off YTD...if not outright implosion...has been in the high beta, Russel 2000 space. With growth...not in fact growth but recession in fact...who has the best chance of "making hay" here?

In the world of buy low/sell high that would be small caps in my book...especially with interest rates this low and "the money spigots" WIDE open. I still haven't pulled the trigger...don't know why...but I expect I might. Having sniffed out this recession for over a year I'm holding back on one more leg down I guess.

buzzsaw99's picture

the fallacy that will soon be put to the test is that stocks can't crash in a zirp environment. small caps would suffer more than large caps in that scenario imo.

Miggy's picture

It's true. If interest rates were ever go to "normal" the whole thing collapses. I see war or dollar collapse first.


John 3:16

NYPoke's picture

Central Bankers have done this for centuries.  They WILL raise rates, as part of the Credit Cycle.  Loose Credit, Tight Credit, Loose Credit, ...


99% sure that this round will trigger deflation.  Different order of events, but the same basic game as the '30s.  Rates & Money Supply/Credit aren't the same thing, but the same people control them both.


Same basic game as Drug Dealers.  Hand out easy credit for 10-15 years.  Get the people addicted.  Pull the easy credit & raise interest rates.  Use the 14th Amendment to force taxes up, to pay for rising interest the bonds roll over into new issues.  Variable Rate Bonds are even worse, straight from Satan.


Bankers OWN the people, with the government doing the dirty work.

Chief Wonder Bread's picture

The secular bull market in 30 yr Treasuries will end someday, to state the obvious.


Thomas's picture

That would be correct. It will also be epic.

deflator's picture

Not convinced that it will be tradable, too much politics involved and the FED is your counterparty?

They ride this bull until bull status is taken from them by force, and I don't mean force of markets.

Fuh Querada's picture

Significant entities investing in bonds are pension funds. So it's all OPM (other people's money). Do you think that your pension fund manager gives a fat fuck if your pension capital is worth nothing when you retire, at which point he is 5 jobs further on?

PoliticalRefugeefromCalif.'s picture

It's worse, they have to stay in the burning house while everyone else awake leaves- going to be a lot of bleeding out when pension funds hit reality..

debtor of last resort's picture

Nice to know governments can't afford market rates.

crazzziecanuck's picture

Big government is what's allowing bankers to keep their heads on their shoulders.

bugs_'s picture

just endgame Keynesian abomination - nobody knows what they are worth because there is no market - everyone - including Yellen and Lagarde know that they are worthless.  instead of a deflationary collapse or an inflationary blowoff the powers that be now seem to be studying massive restructurings based on the SUPERCUTS buy in model.  the promised pensions (that were always a lie to begin with) will be part of the restructuring.  the Keynesian high priests think they continue the game with painful restructuring of the welfare state's lies.  this is the most dangerous moment for them - when they think they have a consensus fix and something unexpected comes out of left field to knock it all down.

I Write Code's picture

Ice cream is now sold in 1.5qt tubs.

The terrorists and banksters have already won.

PoliticalRefugeefromCalif.'s picture

  ..The terrorists and banksters have already won..


AdvancingTime's picture

I contend the primary reason that inflation has not raised its ugly head or become a major economic issue is because we are pouring such a large  percentage of wealth into intangible products or goods. If faith drops in these intangible "promises" and money suddenly flows into tangible goods seeking a safe haven inflation will soar. Like many of those who study the economy I worry about the massive debt being accumulated by governments and the rate that central banks have expanded the money supply.

The timetable on which economic events unfold is often quite uneven and this supports the possibility of an inflation scenario. A key issue being one of timing. If the price of gas jumps to $8 a gallon overnight do you buy gas and not make your car payment or stop driving the twenty miles to work? Answer, it could be months before your car is repossessed so you buy gas.

 It is important to remember that debts can go unpaid and promises be left unfilled. If this happens where does it  leave us? Chaos and major disruption would result from such a scenario. As we have seen from the economic crisis of 2008 and following many other unsettling developments legal actions can continue to drag on for years.  More in the article below.


deflator's picture

"When a central bank dominates the domestic bond market, all bets are off"


It would seem that without the shackles of sound money that the FED can manipulate markets toward maintaining the status quo of infinite economic/government growth without consequence. It has only been about 40 something years since the FED and USD hegemony has decoupled from consequences/GOLD backing.

Globalizations massive parabolic growth over the past 40 years has contributed to the psychology that Central banks can manipulate without consequence and it is globalization that will ironically bring about the consequences.

Just 10 years ago when global growth was still parabolic any talk of supplanting the dollar as world reserve currency was only in dark corners of academia. At the global macro level, 40 years is a short period of time for proof that unsound money policy is here to stay. After all, the world is a pretty big place, but it isn't infinite as the debt buildup would suggest.

It is just a matter of time until sound money reasserts itself in the realm of all things economic.

drstrangelove73's picture

"There is nothing new under the sun"
"You don't get it,old man.It's different this time"
"Novus ordo Seculorum"
We'll see,won't we boys and girls?

gdpetti's picture

Inflation doesn't need higher interest rates, the two have been disconnected by the Fed et al. Inflation is now a stand-alone factor in the economy that the govt finds best to ignore, which they can as long as they can keep our eyes on their prize and not one of our own choosing. It's all a con game.... short for confidence, or as Bernie put it, a global Ponzi scheme and we know how those always, repeat always end.

NEOSERF's picture

My $92 bag of groceries from Whole Foods says there might be a wee bit of inflation.