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The Bond Market Has Reached Tulip Bubble Proportions
By EconMatters
Fed Officials Trying to Send Signals to the Bond Market
James Bullard on Friday noted that the Bond Market was far too dovish in relation to where the Fed is in regard to raising rates in June, and this might be the understatement of the year so far. For example the U.S. 2-Year Bond Yield is 0.45 or 45 basis points, think about this for a moment. Even if the Fed fund`s rate finishes the year at 50 basis points which is well below the Fed`s most conservative forecasts, and we use a conservative annual inflation rate of 1% (I know oil has dropped but there are more inflation categories than just the energy component). Moreover, the overall annual inflation rate is well above 1% right now, and you factor in that this bond is paying a 2-year risk premium for tying up one`s capital with all kinds of inflation risks over that 2-year time frame, this has to be the stupidest investment of all time.
2-Year U.S. Bond Yield is 45 Basis Points
To buy the 2-Year Bond when the Fed has practically stated that after two FOMC meeting`s they are liable to raise rates at least 25 basis points at the earliest (think April) and June at the latest so that is 25 basis points right there added to the Fed Fund`s rate, and needs to be added to the 2-Year Bond calculation so the current Fed target rate is 0.00 - 0.25 with the daily rate on 1/29 of 0.11 or 11 basis points, so add the June 25 basis rate hike to the current daily rate of 11 basis points and you get a 36 basis point starting point for borrowing money, add an annual inflation rate of 1%, and we are at 136 basis points for evaluating the 2-Year Bond given this rather charitable and conservative analysis.
Read More: European Bond Market: Bubble of all Bubbles!
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June Rate Hike Telegraphed to Markets
Remember this June rate hike by the Fed has been pretty well telegraphed to market participants, and nothing changed in the latest Fed Statement in fact it became even more hawkish with language changes in the statement released this week. Therefore whether one completely takes out the inflation component leaving a 36 basis point starting point, a 45 basis point yield on the 2-Year is beyond absurd. It is an example of just how much risk taking and froth there is currently in the bond markets due to so much cheap money sloshing around the financial system right now. The only way an investor can make money with a negative real rate of return if you factor in the inflation rate is by using an insane amount of leverage on these very low borrowing costs. Low borrowing costs aren`t enough to make this trade work, it takes huge scale to make this a ‘worthwhile trade’ in a negative real rate scenario that this trade offers up to the risk taker.
Leverage & Bond Market Instability in Overcrowded Trade
Therein lies the problem for the Federal Reserve and Central Banks around the world, they have enticed investors to chase yield at negative real rate scenarios with huge leverage to make such a low yield vehicle trade profitable and worth doing. This is going to cause massive instability to the financial system when this trade ends like we all know it will because the numbers involved are nonsensical to say the least.
Unemployment Rate 5% in 2015
Just on Friday one of the most dovish members of the Federal Reserve, San Francisco Federal Reserve Bank President John Williams said the U.S. will see real GDP growth around 3 percent in 2015, and that the unemployment rate will touch 5 percent by the end of the year. Where do traders think that leaves the Fed Funds Rate? The U.S. 2-Year Bond is currently pricing in no rate hike for all of 2015 and 2016, and no inflation whatsoever, in fact a negative rate of inflation over the next two years.
The Tulip Lunacy in the Bond market is just off the charts stupidity at its finest, go ahead and buy the 2-Year Bond this upcoming week, I am sure this Bond will be good in four months when the Fed hikes rates 25 basis points, maybe if you are lucky there is a greater fool than you, but from the stampede that is sure to follow on the exit of this trade at these prices in the bond markets, you better be first!
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German and Japanese bonds are yielding much lower, so it is no wonder Treasury bond prices are increasing, especillay with a rising U.S. dollar.
So, if one is against austerity, against the big criminal banksters, you're branded a lefty, a communist...?
http://rt.com/news/228223-podemos-mass-rally-spain/
No truth to the rumor that Chauncy Yellen spends all her time in the garden.
Boycot this junk, toxic , paper . . Dump what you have . . Crash and Burn. .
I think one significant issue this article ignores is the significant shortage the Fed (and other banks) have created in long term US treasuries.
The scenario the Fed has created is this:
On the demand side for US treasuries we see:
So despite the $17+ trillion US debt and negative real interest rates, we have a many trillions in "printed liquidity" sloshing around looking for somewhere to land. The US economy is a pig with lipstick, but its the least ugly pig in the pig pen right now with collapsing commodities, crashing emerging markets and volatile stocks.
So US treasuries are actually in short supply right now, particularly at the long end, and in the short term I would not be surprised to see some interest rates go negative as foreign stock markets and US equities get even more volatile. Even if Yellen raises the short term interest rate, I'm not convinced it will have much impact on treasuries until the current crisis in currencies, equities and commodities passes.
What will ultimately drive US rates higher is when we see the excess liquidity destroyed en-masse. That process has started in the emerging and commodity markets - billions in oil investments, carry trade, etc have disappeared already. But I think it will take a little longer and hit the US and we'll see that the US stock market (and derivatives market) will plummit before we see the bond bubble pop. We'll see deflation (commodities, equities, assets) before we see significant inflation.
Generally agree.Excess savings has resulted in overinvestment all over the world, to the extent that there are no investments available where the profit is sufficient to balance risk. The only options are chasing bubbles or accepting a negative yield. Either way, the savings will be destroyed. Think of money/savings as a claim on future production. If there are an excess of claims on future production, it can be resolved by devaluing the claims (inflation), or by destroying money/savings in bursting speculative bubbles. The bubbles result in deflation as overinvestment leads to overproduction and the cost of commodities like oil ultimately goes down. Central banks are perversely fueling the bubble process by lowering rates and printing even more money/savings out of thin air. The choice between inflation and bubbles is probably closely related to the power of labor in the economy -- if it is first or last in line to claim any savings. Right now the power of labor as a whole seems pretty low...
In evaluating what will happen you have to consider if the Fed sets rates, or just sets them to follow the the macro monetary environment. I think the latter. Right now I think the fed is jawboning to an extent, and will probably wait until the summer to set rates based on whats happening. Given that oil, lumber, copper, Baltic Dry Index, CAT etc are in decline I'd say by summer we will be in a strong recession, and the fed will not raise rates.
I should also say that the market would do a better job of setting rates than the fed. Right now I'd like to see a natural rate on the 10 yr of 8%
Sure is a marvelous distraction though, there is that, makes it seem like you have a real market 'n all.
bullard is a retard. the bubble is in equities.
Bingo.
Bullard is a retard (Drater) and EconMatters is also a retard. ZH and Tyler too for letting such a stupid article be posted.
To say Bonds are in bubble trouble becuase the 2yr has a low yield is just stupid.
Have a good weekend.
NoVa
Exactamundo Buzz. That and it "Takes a Village"
The other night Mrs K and I had the opportunity to have dinner with a number of folks and their wives. "They" were firmly of the 1%. We were very quiet as it was a prime opportunity to be still and listen, especially as the wine had lubricated their candor. Their lack of understanding of the world about us was shocking. They were firmly of a trickle down, we're under attack, if you tax the 1% we'll all die mentality and even some asked (seriously) "What's wrong with Obama? I need to be able to tell the kids." Oy!
The other side of the coin is our "stereotype" ZH'er. The world will end tomorrow, stawlks and bonds and fiat is bad, stack or die, etc.
Both are down some pretty severe rabbit holes each as disconnected from reality as the next.
And both think their reality is true collective consciousness reality.
(clearing throat)
The problem with most folks is that they think that sitting in the audience of the beauty contest, it is logical that they pick who they believe to be the best looking to forecast which participant will win. Nope. Their job is to pick the girl that the judges think is the prettiest one who will win. It's the judges, not them that pick the "prettiest". The judges comprise more of the votes in the aggregate than the individual, just as an aggregate demand curve is comprised of everybody, not just you or me. We're part of it. They forget there is a collective consciousness within which their own consciousness participates.
An error called ego.
I'll take the bonds are more right than stocks simply based upon historical evidence that bonds have been the better leading indicator of future events as opposed to equities, in spite of what equity people claim.
After all, don't forget that tulip bulbs were "growth equity" substitutes ... Hah ha ha ha
Seriously....
Be well.
K
So, I borrow at the Fed window at 0.25%, and invest it in US Gov. Bonds that yield 0.50%. Since 0.50% is twice 0.25%, I will earn a 100% profit. Right? What could go wrong?
I'm off to tell Curly and Moe about my new sure-fire investment strategy.
Bad math. In fact, one makes 0.25% profit on the total. Having said that, the money is free, the return guaranteed, and the risk zero (at least in nominal terms).
Look at Japan, it has been going on for 25 years. Bond bubbles are long living, but the pop will be gigantic.
The Tulip mania bubble is, if not an urban legend, at least greatly exaggerated.
"Mike Dash, author of the modern popular history "Tulipomania," states
Granted. Nothing like we are seeing today. But the tulip bubble serves as a good example of expansionary money.
http://mises.org/library/truth-about-tulipmania
Still good reading.
http://en.wikipedia.org/wiki/Extraordinary_Popular_Delusions_and_the_Mad...
We are easier to delude today.
There are some people still living large off the whole ratite thing from our lifetimes. (Livestime?)
Global flight to safety. Been out of equities for two years (thanks to the shit I started reading here at ZH). Digging my position now but lost out on the mindless cattle drive. Little options left but to stack on.
TBTFs own FED and Treasury and the bonds, so what does it matter? They run the whole scam. All they're trying to do is conjure an ongoing claim on real-resources via printing one. So of course that's going to debase all claims. And as you've observed, that's what it amounts to. Crooks, pissing in the punch bowl, to top up the diminishing liquidity, then putting the resulting free drinks on the public tab. So everything ends up smelling and tasting like effluent, and no one wants to play anymore. i.e. MMT
With YOY CPI inflation turning negative in more and more countries, with Japan and China heavily exporting deflation, bond yields have to fall further for real rates to stay the same. Just looking at the creditworthiness of the governments is not sufficient IMHO. Not so sure whether this is truly a bubble or just a reflection of the deflation all around us.
It's not just deflation or a bubble, its like your name...a PONZI.
To Be sure people on both sides of a 0.45% trade will be wiped out over the next 18 months.