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Bob Shiller Asks "How Scary Is The Bond Market?" (Spoiler Alert: Not Very)
Authored by Robert Shiller, originally posted at Project Syndicate,
The prices of long-term government bonds have been running very high in recent years (that is, their yields have been very low). In the United States, the 30-year Treasury bond yield reached a record low (since the Federal Reserve series began in 1972) of 2.25% on January 30. The yield on the United Kingdom's 30-year government bond fell to 2.04% on the same day. The Japanese 20-year government bond yielded just 0.87% on January 20.
All of these yields have since moved slightly higher, but they remain exceptionally low. It seems puzzling – and unsustainable – that people would tie up their money for 20 or 30 years to earn little or nothing more than these central banks' 2% target rate for annual inflation. So, with the bond market appearing ripe for a dramatic correction, many are wondering whether a crash could drag down markets for other long-term assets, such as housing and equities.
It is a question that I am repeatedly asked at seminars and conferences. After all, participants in the housing and equity markets set prices with a view to prices in the bond market, so contagion from one long-term market to another seems like a real possibility.
I have been thinking about the bond market for a long time. In fact, the long-term bond market was the subject of my 1972 PhD dissertation and my first-ever academic publication the following year, co-authored with my academic adviser, Franco Modigliani. Our work with data for the years 1952-1971 showed that the long-term bond market back then was pretty easy to describe. Long-term interest rates on any given date could be explained quite well as a certain weighted average of the last 18 quarters of inflation and the last 18 quarters of short-term real interest rates. When either inflation or short-term real interest rates went up, long-term rates rose. When either fell, so did long-term rates.
We now have more than 40 years of additional data, so I took a look to see if our theory still predicts well. It turns out that our estimates then, if applied to subsequent data, predicted long-term rates extremely well for the 20 years after we published; but then, in the mid-1990s, our theory started to overpredict. According to our model, long-term rates in the US should be even lower than they are now, because both inflation and short-term real interest rates are practically zero or negative. Even taking into account the impact of quantitative easing since 2008, long-term rates are higher than expected.
But the explanation that we developed so long ago still fits well enough to encourage the belief that we will not see a crash in the bond market unless central banks tighten monetary policy very sharply (by hiking short-term interest rates) or there is a major spike in inflation.
Bond-market crashes have actually been relatively rare and mild. In the US, the biggest one-year drop in the Global Financial Data extension of Moody's monthly total return index for 30-year corporate bonds (going back to 1857) was 12.5% in the 12 months ending in February 1980. Compare that to the stock market: According to the GFD monthly S&P 500 total return index, an annual loss of 67.8% occurred in the year ending in May 1932, during the Great Depression, and one-year losses have exceeded 12.5% in 23 separate episodes since 1900.
It is also worth noting what kind of event is needed to produce a 12.5% crash in the long-term bond market. The one-year drop in February 1980 came immediately after Paul Volcker took the helm of the Federal Reserve in 1979. A 1979 Gallup Poll had shown that 62% of Americans regarded inflation as the “most important problem facing the nation." Volcker took radical steps to deal with it, hiking short-term interest rates so high that he created a major recession. He also created enemies (and even faced death threats). People wondered whether he would get away with it politically, or be impeached.
Regarding the stock market and the housing market, there may well be a major downward correction someday. But it probably will have little to do with a bond-market crash. That was the case with the biggest US stock-market corrections of the last century (after 1907, 1929, 1973, 2000, and 2007) and the biggest US housing-market corrections of all time (after 1979, 1989, and 2006).
It is true that extraordinarily low long-term bond yields put us outside the range of historical experience. But so would a scenario in which a sudden bond-market crash drags down prices of stocks and housing. When an event has never occurred, it cannot be predicted with any semblance of confidence.
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LOL.
The question is, how much are you willing to pay the government to hold your money?
Who's money?
How scary is this advice?
my roomate's step-mother makes $79 hourly on the laptop . She has been fired for 10 months but last month her pay was $18694 just working on the laptop for a few hours. see here... www.globe-report.com
volcker, my hero
+1
R"egarding the stock market and the housing market, there may well be a major downward correction someday".
Boy, this dude does some very deep thinking!
Highly riveting insight from this man no question.
Scarier than Hillary in biker chaps holding a branding iron and gag ball.
Just keep chanting- 'Everything is awesome, always and forever'
D-D-Deflation
So past performance equals future performance???
I thought we paid economists to get the economy moving?
Perhaps he could explain how the USA is having the biggest energy and tech boom in history and still has not only zero growth but actual recession prints popping up everywhere?
Mr chug-along. What a waste of economic resources at his university.
There has never been a better time to buy an ivory tower.
but never a worse time to quit sniffing glue
For those who've been paying attention, ZH has been generally bullish on long term treasuries for at least a year and a half, and it's been exactly the right trade. And as the 30Y resumes its death march to the 2% yield level, it will continue to be.
Wow, 2% for holding that crap for 30 years. I just find it mind-boggling.
Ran into a Wall Street financier on a gondola in Killington this past week. He said it was great that the Federal Reserve and the Federal Government were propping up the stawk market even though it means 92 million unemployed. He said to me, "Isn't that great?" I told him, "The difference between you and me is that I funded my snowboarding trip here with my own productive capital and that I didn't steal from pensioners or the purchasing power of others."
He smuggly replied, this is the way it has always been and will always be. It's great for me."
I laughed at him and said, "We shall see how long all of yur imaginary wealth lasts when Kind Dollar is dethroned."
SMug asshol.e
"When an event has never occurred, it cannot be predicted with any semblance of confidence"
The highest paid whores know the importance of maintaining an appearance of chastity for next time they are needed. This paid whore knows EXACTLY why this time is different.
I want to know what happened in the mid 1990s to cause his model to start overpredicting.
Exactly. Biggest bond bubble in human history? Global fiat currencies hyperinflating? Who cares!
According to him, evidently yields are headed to negative infinity for all time.
1996. the year rates behaved funny. lots of banks... wobbled
a legacy of 96 is that I always compare prices with 1995. I dubbed it "the last serious price year"
anyone else remember that CNBC narraitve about "the great rotation" and how all this $$$ was going to come POURING out of bonds and flow into stocks in 2012, then 2013, then 2014, then ... oh wait, they gave-up on that 1 last year since it never happened
High school fund raisers are run more professionally than our country.
Again, none of these 'experts' discuss the big supply \ demand equilibrium.
For 5+ years QE bought up all of the incremental supply of Treasuries. Supposedly, they have stopped which means there is now $1T more in supply every year. And that is just the US. The EU is beyond full too.
How much do they think EU QE will gobble up of their issuance and our issuance.
When the supply \ demand gets out of whack the prices will go bye bye.
"because both inflation and short-term real interest rates are practically zero or negative"
I don't know what he is talking about -- Inflation appears to be pretty healthy in whatever I buy!
He means the fake inflation numbers, of course. That goes along with the non-mark-to-market, MBS buyer of last resort, TBTF, plunge protection, lower unemployment because benefits ran out, etc.
There may be a correctoin "someday." Dr Bob obviously does not look at his own charts?
He's about to be draggad away to jail for using the "D" word.
[deflation]
No one believes bond yields are about to soar...but they are.
http://www.globaldeflationnews.com/10-year-u-s-treasury-index-yieldellio...
"...When an event has never occurred, it cannot be predicted with any semblance of confidence..."
Bernanke, mid '00s: 'There has never been a downturn in housing prices, at least since the Great Depression.' (Therefore, it will not happen).
Oops.
Shiller's model of long-term interest rates is a function of 18 quarters of inflation and short-term real rates. Both of those data series are gamed big-time by BLS and FRBNY/Treasury.
He is defacto banking on FRBNY/Treasury maintaining control of all elements of the Treasury market. I do not think that will be the case.
I think he ends up with egg on his face, big-time.
In this case, Shiller is being a "shill" for the gubment. Probably even asked to write something fairly positive about bonds.
That said, I think he is correct that it is unlikely the bond market will have a violent correction. What he didn't say is...without a significant market affecting event. That is the real issue here. When confidence gets slowly removed, no one really knows what it will take to start the stampede.
The stampede will kill the bond market. I don't now what will cause it but I know that the current conditions support a lot more scenarios for stampede than a healthy market would.
Well, actually he sorta did say that, though perhaps not as dramatically as you prefer. What he said was (extracted from his article above) is...
... we will not see a crash in the bond market unless central banks tighten monetary policy very sharply (by hiking short-term interest rates) or there is a major spike in inflation.
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Note that he does not rule out dramatic moves that are slower than "a crash". All his comments are about "a crash", which means "happens fast".
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Many of us here in ZH comment-land have noted that given the debt-level of the fictitious USSA government, they CANNOT stand much higher interest rates. And since the predators-DBA-USSA and predators-DBA-federalreserve are absolutely NOT independent, but in fact utterly symbiotic creatures, the federal-reserve will NEVER jack interest rates higher as long as the debt-load remains high. And since the debt-load will always remain high (until the point the USSA suffers a complete political collapse), one can expect interest rates on government debt to remain low indefinitely.
That just makes sense, and I suspect that's all he is saying.
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PS: What happens with interest rates on private debt is a whole different question. In anything remotely like a "free market" much higher interest rates on private debt would force interest rates on government debt to be higher, otherwise the market for government debt would vanish.
However, anything remotely like a "free market" is long dead now, and everyone knows the federal reserve will happily buy UNLIMITED quantities of federal government debt at low interest rates, no matter what conditions exist for private debt.
Right. The US is following the script from Japan, except that the US is not a net exporter and immigration is helping the US out (despite outrageous fear mongering.)
What held value in Japan? During the lost decades gold price in yen shows a decrease in the first 10 years, and then steady growth of 3x over the next 15 years.