Submitted by John Aziz of Azizonomics [10],
I admit the headline is a little sensationalistic, but after Wednesday’s WTF bond auction [11], I feel like slapping the market around the face with a rotten fish. Now certainly there are plenty of penny stocks headed to greater losses far sooner. And certainly, lots of people have made good profits on Treasuries by buying them and flipping them to a greater fool or a central bank. On the other hand, so did many during the NASDAQ bubble, or during the ’00s ABS bubble. Bubbles are profitable for some, and that’s why there have been so many throughout history. But once the money starts to dry up they become excruciatingly painful.
Treasury yields are just going lower:
[12]
After a 30-year bull market, you’d think that the financial media might have cottoned onto the idea that there is little scope left for real gains, either by holding bonds to maturity (inflation is outrunning yields [13]) and even by flipping it off to a greater fool (or the greatest fool of all — the central bank).
In theory, there are no limits to how low rates could go. In theory, nominal yields could go deeply negative, so long as there are buyers coming into the market ready to buy at a lower rate, and a push a profit to bond flippers. In reality, even Japan — a nation that has adopted desperate measures including forcing financial institutions to buy treasuries to keep rates depressed — has not managed to push nominal rates below zero. The scope for great profits from flipping bonds seems to be evaporating. And in any case, the latter case of flipping bonds to a greater fool or the central bank balance sheet is a classic characteristic of a bubble. The inherent value in a bond is its yield; everything else is speculation.
In the classic bubble mentality, more and more financial media [14] — hastened on by the prospect of deflation [15] (something which the Fed is absolutely obsessed with preventing, and is prepared to print an unlimited amount of money to do so) — are calling Treasuries something that you can’t afford to not own.
The reality, though, is that even recent years treasuries have not really been a good investment. Bond prices may have gone up, but they’ve been eclipsed by a harder kind of asset — gold:
[16]
Indeed, the real bull market in bonds ended in the ’90s. It’s not just that bond bulls are running out of steam; next to gold bulls they have made a relative loss. Here’s what I call the gold-denominated real interest rate (or the “real real interest rate”) on the 10-year treasury — rates minus the percent change in the gold price:
[17]
While the bond flippers have done well (just as the NASDAQ-era bubble merchants did well flipping Pets.com to a greater fool), whoever is holding bonds to maturity is gradually pouring purchasing power down the drain. And that is the problem; the only way that the bond flippers can get their pound of flesh is for the Fed to print a whole swathe of money and buy the flippers flip-offed bonds. And however depressed the economy is, printing money to absorb treasuries is hazardous to the currency [18], and irritating to the largest treasury holders [19] — who America happens to import a lot of goods and oil from — who hold treasuries to maturity instead of flipping them off. A trade war between America and her creditors seems inevitable and the bond flippers on Wall Street may end up being dragged under the bus by such an event — perhaps getting paid off in a heavily devalued dollar and losing their shirt on a bond-flipping trade where they initially only stood to make a sliver of a percent gain [20] on their stake (made even riskier by concentrated ZIRP leverage).
It is hard to really call the timing on the end of a bubble. People and events can always get more irrational. Japan has kept the Treasury ball (painfully) rolling for far longer than most of us expected (through market rigging as much as anything else [19]). But this cannot end well.