The Name Is Bond, Long Bond

Authored by Mike Shedlock via MishTalk,

Stories about the death of the bond market have been circulating since 1992. Every one of them has been wrong...

Deflationary Period Over?

At Mauldin's latest conference, Gavekal's Louis-Vincent Gave stated “The deflationary period we’ve been in has come to an end.

He produced this chart.

As told through the words of Steve Blumenthal ... Louis-Vincent continued, “Or simply look at this (next) chart. I mean this is obviously the 30-year US Treasury bond yield, which is now, of course, broken out decisively from its downtrend, which makes sense if this deflationary environment that I’ve described is now coming to an end. And here, I just want to spend a quick second on this because I think this is very important. The markets today are giving us a very important signal.

Crayon Shortage

There appears to be a shortage of crayons.

Gave need a fatter crayon, a longer crayon, or better vision.

My chart shows the 30-year long-bond has not broken its trendline. Perhaps it will, but it hasn't. Until it does, the alleged "signal" is as valid as the ones in 1990, 1994, 2000, and 2007.

Don't Jump the Gun

We have not seen a secular change yet. It's very tempting now, just as it was in 2007, to jump the gun.

Don't do it!

Hoisington Management

Lacy Hunt at Hoisington Management is one person who has not jumped the gun.

He also presented at Mauldin's conference.

I do not have a copy of Hunt's presentation as it is still embargoed. But I do have a copy of the Hoisington Management Quarterly Reviewand Outlook for Q1 2018 (not yet posted online).

Hunt discusses the Law of diminishing returns, technology and debt. Here are a few snips:

The law of diminishing returns is already evident in all major economies as well as on a global scale. Global GDP generated per dollar of total global public and private debt dropped from 36 cents in 2007 to just 31 cents in 2017.

Diminishing returns is even more apparent in the case of China’s public and private debt, largely internally owned. In terms of each dollar of debt, China generated 61 cents of GDP growth in 2007 and only 33 cents last year. In other words, in the past ten years the efficiency of China’s debt fell 45%.

The most advanced sign of diminishing returns is in Japan, the most heavily indebted major country, where a dollar of debt in the last year produced only 22 cents of GDP growth. This economic principle applies equally to businesses.

In 1952, $3.42 of GDP was generated for every dollar of business debt, compared with only $1.39 in 2017. In the corporate sector, where capital as well as technology is most readily available, GDP generated per dollar of debt fell from $4.50 in 1952 to $2.50 in 2007 to $2.21 last year. The dismal trend in productivity confirms this conclusion.

The percent change for productivity in the last five years (2017-2012) was equal to the lowest of all five-year spans since 1952. It was also less than half the average growth over that period.

Conclusion

Important to the long-term investor is the pernicious impact of exploding debt levels. This condition will slow economic growth, and the resulting poor economic conditions will lead to lower inflation and thereby lower long-term interest rates. This suggests that high quality yields may be difficult to obtain within the next decade. In the shorter run, in accordance with Friedman’s established theory, the current monetary deceleration, or restrictive monetary policy, will bring about lower long-term interest rates.

Other Opinions

Other opinions are easy to find. For example Bloomberg reports Yield-Inversion Fear Pits JPMorgan Against Aviva Fund Manager.

Some have started to fret the bond market is portending a recession. Not James McAlevey.

The fixed-income fund manager at Aviva Investors, which oversees 243 billion euros ($301 billion) of bonds, is instead loading up on risk and yield curve-steepener trades. He expects the U.S. economy to expand -- not shrink.

“The recent trade shocks aside, the U.S. economy looks like it’s on pretty firm footing,” McAlevey said in an interview.

The yield curve can’t be trusted because overzealous central bank purchases have pushed down yields and the term premium, or compensation for buying longer-dated debt, according to McAlevey. And that’s set to change as the Fed runs down its balance-sheet holdings, foreign buyers withdraw, and growth and inflation pick up.

“If the term premium goes up through time, the yield curve should start steepening,” he said. He says the gap between two- and 10-year notes, now at 48 basis points, could return to early 2017 levels of about 125 basis points.

Steepening?

I expect steepening but in the opposite sense of James McAlevey.

Steepening will occur when the Fed starts slashing rates in the next recession praying like mad to stave off debt defaults.

One Sided Boat

Seldom is opinion as certain about anything as it is today.

I discussed that idea a couple of days ago in Opinion Nearly Unanimous: Inflation Has Arrived.

One Question

I have a simple question: When is the last time such overwhelming consensus on a fundamental economic issue ever been right?

I do not rule out an inflation scare, just as we had in 2008 when crude spiked to $140.

In fact, the above Tweets and articles show it's clear we are in the midst of such a scare right now.

When?

Yes this bond bull will end. But when?

Meanwhile I side with Lacy Hunt.

I asked him today about his average duration. He replied "a little over 20 years".

That's quite a conviction, and quite opposite what the consensus inflationista thinks.

The Name Is Bond

The name is Bond, Long Bond Hunt.

Comments

CarthaginemDel… Fri, 04/13/2018 - 11:10 Permalink

Good article totally agree. Fed will have to reverse as soon as we hit recession probably sometime this year. Bond bull will end at the end of the next recession. Deflation before we ll hit hyperinflation.

taketheredpill Fri, 04/13/2018 - 11:19 Permalink

US 10 Year hits top of 30 year Trading Channel and then drops?  CHECK

US 2-10 Year Yield Curve Flattening (at 47 bp and falling)? CHECK

US Treasury Bond Sentiment at Lows (In November JP Morgan Sentiment Indicator hit 2005 levels)? CHECK

 

Recession and (GOVIE) Bond rally is coming BUT....be nimble because Fed will cut through Fed Funds in no time and market will quickly start to price in QE.

And because the underlying issue (debt, debt, and debt) has not been addressed, the Central banks will come in with MOAR QE.

QE crushes Treasury Bonds and will destroy US Dollar.  Good for Gold.

And to the extent that Trade Wars herald the end of cooperation, there is a chance that "coordinated QE" is also over.  Which means it will be harder than ever to find the "safe" currency......

Which is also good for Gold.

TuPhat NemesisteM Fri, 04/13/2018 - 13:37 Permalink

Shedlock doesn't know it but the bond market died when I took my money out in 2013.  For me there is no bond market when J P Morgan's prospectus says I can plan to lose at least 1%.  The big banks still have a market but the little guy only gets the shaft.  Stocks are pretty much the same.  I haven't lost any money on bonds or stocks since 2013.  Inflation is a different matter.  I can skip the gains, the losses and the headaches.

In reply to by NemesisteM

aeslong Fri, 04/13/2018 - 11:35 Permalink

chart is bull shit. there is no so called "market", only manipulation. for rate, only matter is debt. debt is inflation killer, period.

CHX13 Fri, 04/13/2018 - 11:40 Permalink

Get paid NRIRs... While long long bond *might* be a good mid-term bet, the outstanding debt is just way too big and ultimately the buying power of the currency/dollar will be toast... Only winning move is not to play *their* game.

GOTS (as much as you can), Ag+Au, and GLTA.

artvandalai Fri, 04/13/2018 - 12:37 Permalink

If you look at the longest term charts like this article does then I suppose you think it's still a bull market because it hasn't broken a trend line. Except for maybe the 30 year treasury there hasn't been a new high for 6 years. And everything but the 30 year treasury is in a bear market pattern.

Ink Pusher Fri, 04/13/2018 - 12:52 Permalink

*** In a nutshell...

"... For the next two years the federal deficit will be rising – moving from roughly 3.6% of GDP in fiscal 2017 to 3.7% of GDP in fiscal 2018 to 5% of GDP in 2019. Thus, the continuing debt buildup will have the unintended consequence of slowing economic growth in 2018 and beyond, despite the favorable multiplier contribution that individual tax cuts impart."

http://www.hoisingtonmgt.com/pdf/HIM2017Q4NP.pdf

Salmo trutta Fri, 04/13/2018 - 14:23 Permalink

Everything was explained and predicted in the late 1950's, the turn in 1965, the turn in 1981, the S&L crisis, the 1990-1991 recession, the GFC, etc.

Bonds are rising and yields dropping because money velocity started decelerating in 1981. 

Secular strangulation began in 1981, with the saturation of commercial bank liability innovation, viz., the widespread introduction of ATS, NOW, and MMDA accounts.

See Lester V. Chandler:

“Professor Pritchard is quite right, of course, in pointing out that commercial banks tend to compete with themselves when they issue savings deposits.”

Pritchard never minced his words, and in May 1980 pontificated that:
“The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”. And the rest is history.

As Dr. Leland James Pritchard (Ph.D., Economics, Chicago, 1933, M.S., Statistics, Syracuse) proposed in the late 1950’s:

“Savings require prompt utilization if the circuit flow of funds is to be maintained and deflationary effects avoided”…”The growth of commercial bank-held time “savings” deposits shrinks aggregate demand and therefore produces adverse effects on gDp”…”The stoppage in the flow of funds, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods.” Circa 1960

No, savings never equals investment. Take the “Marshmallow Test”: (1) banks create new money (macro-economics), and incongruously (2) banks loan out the savings that are placed with them (micro-economics).
# (2) is obviously wrong from a macro accounting point of view.

In "The General Theory of Employment, Interest and Money", John Maynard Keynes’ opus ", pg. 81 (New York: Harcourt, Brace and Co.), gives the impression that a commercial bank is an intermediary type of financial institution (non-bank), serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor & his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”

In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term non-bank in order to make his statement correct, viz., the Gurley-Shaw thesis, the DIDMCA of March 31st 1980 which directly caused the S&L crisis.

This is the source of the error that characterizes the Keynesian economics.  Steve Keen actually gets it right.

 

 

 

 

 

 

Salmo trutta Fri, 04/13/2018 - 14:26 Permalink

Interest is the price of loan-funds, the price of money is the reciprocal of the price-level.  But eventually there will  become a more dominant demand side factor (as opposed to supply side factors, e.g., inflation), federal deficit spending (crowding out the private sector).

Knave Dave Fri, 04/13/2018 - 23:47 Permalink

Shedlock quotes two opposite views:

"The current monetary deceleration, or restrictive monetary policy, will bring about lower long-term interest rates."

(A view that is utter nonsense, and ...)

"The yield curve can’t be trusted because overzealous central bank purchases have pushed down yields and the term premium.... And that’s set to change as the Fed runs down its balance-sheet holdings."

As the last quote says, the Fed's stated purpose in buying up so much long-term government debt (easing monetary policy in a massive (quantitative) way) was to lower long-term interest rates; and obviously that worked, as long-term interest rates have never been lower. So, clearly reversing that strategy to a more "restrictive monetary policy" is NOT going to "bring about lower long-term interest rates" as the first idiot stated.

Obviously, reversing that strategy is now intended to raise rates, and obviously it has already begun to do that quite dramatically, and that reversal is just getting started. Moreover, the inflation data the Fed looks at (which is the only data that matters for determining what the Fed is going to do with interest) has already risen above the Fed's targeted 2.0% (now at 2.4%), so the Fed is going to find it hard to lower rates into an environment of rising inflation, even though it will need to in order to stimulate the economy very shortly. The Fed is going to get caught between a rock and a hard place.

The idea that bonds won't bust is based on inflation going back down, but that doesn't have to happen in a recession, and it certainly isn't happening right now. However, the idea that bond yield's are determined primarily by inflation is flawed to begin with. Inflation is one major factor that bonds have always had to contend with -- especially long-term bonds where inflation erodes real yield on the bond. 

But a bigger driving factor is supply and demand. Another is FEAR, which tends to move demand toward bonds in search of a safe haven. Right now, the Fed is starting down a path that hugely reduces demand for government bonds because the Fed has been the primary buyer of government bonds (the primary source of demand). As the Fed moves in stages into no longer automatically rolling the old bonds over, that also will leave the government with a larger number of bonds to find buyers for (larger supply) because it has to refinance those bonds.

Therefore, the government will have to drive new buyers to a larger number of bond issues, and that usually requires upping the yields it offers on new issuances. We've already seen that happening.

--David Haggith

http://thegreatrecession.info/blog/