DID THAT SCARY BOND BUBBLE JUST POP?
Interest rates have moved a whopping 20 bps in recent weeks and the bond bubble theorists are ready to pop the champagne. Not so fast there. In trying to put this into perspective I did a little research looking at the only period in US history when bond yields were this low and the macro environment was even remotely similar. If you hop in your time machine back to the 1930′s the environment was eerily similar. Deflation risks abound, low yields, floundering economy, high unemployment, private sector debt bubble, etc.
It’s impossible to say what year we most highly correlate to in the 30′s. Some people think we’re in the early 30′s while others think we’re in the late 30′s, but one thing is clear – the interest rate environment is remarkably similar regardless of where you think we are:
So what happened back in the 30′s? The economy muddled through until WW2 or so and then started to pick up momentum. Interest rates steadied and then rose a whopping 1.5% over the course of the next 20-30 years depending on where we begin. And that’s including the New Deal period when government spending was 120% of GDP! Sound familiar? I’m sure the deficit hawks were puking all over themselves at the time of FDR’s outrageous spending spree.
The greatest irony in all of this hysteria is that those who are shrieking the loudest about rising yields, US government default, etc fail to understand why interest rates would likely rise in the current environment. Despite massive debt levels, private sector de-leveraging, deflation risks, etc the only thing that got interest rates moving higher in the 1940′s was an economic recovery!
“Despite massive debt levels, private sector de-leveraging, deflation risks, etc the only thing that got interest rates moving higher in the 1940′s was an economic recovery!”
Good point, I agree with that, but given that we can’t trust the economic leading indicators, how will one know if we have a real recovery? A few months back the economic indicators seemed to indicate recovery but it was an artificially induced “non” recovery.
To be fair, as TPC has pointed out, those were the gold standard days, and the global economic lineup is very different.
“Despite massive debt levels, private sector de-leveraging, deflation risks, etc the only thing that got interest rates moving higher in the 1940′s was an economic recovery!”
I would note that, at one time, it was considered impossible for an economy to experience both high inflation and high unemployment – then we got stagflation. Perhaps, it might be more advantageous to consider what conditions might lead to both high interest rates and further economic contraction.
Since it is clear that high interest rates are economically depressing, I wonder if the reverse holds: might further contraction itself lead to high real interest rates. The assumptions you seem to be making is that low nominal rates equal low real rates.
I recall from somewhere the view that Taylor Rule currently requires a negative policy Fed Funds Rate of approximately 5%-6%. I could be wrong about this, but it seems to me that if the FFR is 5%-6% above where it needs to be for policy, all interest rates are likely shifted.
Am I missing something here?
I guess the point I am making here is that yields don’t have to appear high to be high.
Watch the 30 year T-bond future/bond ! I am short the 30 year bond ! Isn’t our TPc convinced yet ??
The biggest difference between the 1930s and today is population growth. With a growing population in the 1930s there was a built-in increase in future demand. Today we have policies that inhibit legal immigration and organic population growth. These policies will extend the time to recovery from a deleveraging recession.
The economy muddled through until WW2 or so and then started to pick up momentum.
Except for 1938, GDP growth was strong between 1934 and the end of the war. Per the BEA:
1934 - 17.0%
1935 - 11.1%
1936 - 14.3%
1937 - 9.7%
1938 - -6.3%
1939 - 7.1%
1940 - 10.0%
1941 - 25.0%
1942 - 27.8%
1943 - 22.7%
1944 - 10.7%
1945 - 1.5%
The economy fell off a steep cliff in the years prior to that, so much so that even these strong growth rates weren’t enough to fix it. GDP in 1933 was 45.5% below what it had been in 1929, so the bottom was much deeper than now. It wasn’t until 1941 that GDP surpassed 1929 levels, a reflection of the steepness of the Hoover decline.
The deflation that we have experienced is nowhere close to this, nor have we had the mass bank failures that marked the early 30′s. The risk to the US isn’t so much one of implosion as it is one of stagnancy.
I wonder about the GDP during the war years as a reflection of anything. After all, we were manufacturing stuff for export, but not selling it…just dumping planes and tanks overseas, with little infrastructural investment or domestically-targeted manufacturing (there was even rationing of essentials, dampening domestic consumption, I suspect). Not being an economist, I have no idea about this, but maybe we have to bracket the war year GDP?
I wonder about the GDP during the war years as a reflection of anything. After all, we were manufacturing stuff for export, but not selling it
Much of the increase in wartime GDP came from rising consumption. The war created employment in excess of full employment, which gave a lot of people a lot of money to spend, in spite of rationing. Consumption in 1945 was almost 50% higher than it had been in 1941.
Of course, the greatest source of increase was in government spending, which obviously had much to do with the aforementioned high employment.
When the war ended, government spending was decreased, but consumption continued to grow and business investment spending increased, replacing some of the lost government spending. Government created the foundation for a civilian recovery to take place once the war had ended; thanks to the war, the excess capacity created the 20s was finally absorbed, and the basis for a consumer economy had been created.
This is what I call muddle through:
Interest rates did pick up until the war started the economic recovery. And even after that the move higher was marginal.
The US growth rates of the 30s would make the China of today green with envy.
The problem was relative. The 1933 bottom was so low compared to the 1929 top that the climb out of the hole was still difficult for much of the population.
Like the 1980′s, it helps to illustrate that high growth rates and high unemployment are not necessarily contradictory. The assumption that growth necessarily drives employment in a linear fashion is a facile one.
It is possible for growth to be strong but for the trickle-down effect to be inadequate for the work force. Full employment ultimately came in the 1940s from government creating a demand for labor through defense spending, not through consumption-based economic recovery. The blowout from 1929 was too large for the benefits of recovery to be quick or organic.
I don’t see what your point is. You’re just conveniently ignoring the economic implosion in the first 4 years (and the 1937 double dip) to prove that economic growth was strong in the 30′s when the full picture clearly shows that was not the case….The 30′s were a terrible period of economic growth. Implying otherwise by removing 5 of the data points is just plain silly.
Either way, I have no idea what any of this has to do with the original point. Interest rates remained low even after the robust recovery. The fact that they stayed low through the period that you imply is robust is even more evidence that proves my overall point.
I don’t see what your point is.
I think that I’ve explained it.
The 30′s were a terrible period of economic growth.
Obviously, they weren’t. The greatest difficult of the 1930s was not one of low growth, but of high unemployment. The BEA data makes this quite clear; double-digit growth rates not low, not by any stretch of the imagination. It took a massive stimulus, well beyond what anyone had planned during peacetime, to finally put the unemployment problem to rest.
So let me sum up your comment. The 30′s were actually much stronger than most people think yet yields remained very low. The current environment is at risk of stagnant growth so yields are likely to remain low.
So you agree with me that yields are likely to remain low, but you felt like having a semantic argument about the economic strength of the 1930′s even though your overall point is essentially proving the entire premise at heart here.
Was there actually a point to your comment?
So let me sum up your comment. The 30′s were actually much stronger than most people think yet yields remained very low. The current environment is at risk of stagnant growth so yields are likely to remain low.
The critical problem of the Depression was that GDP imploded to a substantial degree, falling to such depths that even double-digit growth wasn’t enough to get employment back to pre-crash levels within a decade. The problem wasn’t with the growth, so much as it was with the degree of collapse that preceded it.
The situation today isn’t really comparable to the 1930s, as our peak-to-trough in economic output wasn’t anything close to what they had in the 30s. We aren’t likely to have double-digit growth rates, but we don’t have nearly as large of a hole out of which to climb, either.
I wouldn’t assume that today’s low yields are going to last. GDP fell only slightly and the banking system hasn’t collapsed, so conditions today aren’t nearly as bad and we don’t need to do nearly as much in order to recover.
Let’s just mark you down in the bond bubble camp and get on with our lives.
Update:
Stock/Bond Confidence Ratio: Prefers LT Bonds–VUSTX,TLT,ZROZ
Last Buy Signal: 05/07/2010
The Stock/Bond confidence is a REACTIVE indicator and its signals are calculated on WKLY Closing Prices of the RSP,VUSTX,TLT,ZROZ
While some might argue that the “Bond Bubble” has burst.
Looking at the Data on a WK to WK basis gives no definitive signal–
True the action/volume in TLT has been sharp but remember TLT is a trading position not an investing position.
Position Guidelines/Suggestions
Harvesting profits in the Bond Mkt. is never a bad idea–
If you are sitting on 12%+ Short-Term-profit–TAKE IT!
If you are sitting on 20%+ Long-Term–profit–TAKE IT!
Leave the gravy to the Bungie Jumpers and TPC
Simple macro thoughts from the kitchen table:
The US economy has legislated “structual” unemployment–with No Fix in sight.
Consequently–little/no GDP growth based on jobs recovery.
Some might argue this point–why?
Just give them 2yrs of benefits–food stamps–free medical and an odd job here or there–he ain’t heavy–he can fake it.
How about Imports/Exports in the GDP calculation?
If we push the Exports lever just a little bit harder and easy off the Import lever–Shazam–we have 3% GDP growth–problem solved –Ho-Ray for US!
So watch the currency markets for a decline in the US Dollar index and the US-Dollar pairs–
This brings us back to the Bond Mkt–
Bonds and Weak Dollars don’t party well–eyes wide open
Now to politics:
The Dems will do anything to stay in power.
And the Rebs will do anything to regain power.
Whats the difference between a prostitute and a politician
There are some things a prostitute will not do! those pesky standards.
I expect all means and manner of stimulus programs inflicted on the US economy to save Mom and Pop from themselves–a cruel fate awaits.
Stay tuned
TPC’s graphs show how yields varied during the middle years of the last century, but a crash would impact prices rather than yields, and it may not take much of an increase in yields to depress prices appreciably. Are data available showing how bond prices varied in that time frame?
Is TPC not looking at the wrong spot in the graph ?
My personal thoughts when I look at the graphs:
1. What yields ? Are we looking at the 3 month T-bill, the 10 year T-bond or the longbond ?
2. The US had a Current Account Surplus in the 1930s but currently it has a Current Account Deficit. This leads – IMO – to higher rates in the US in the next months/years.
3. Can you overlay the performance of e.g the DOW with the yield of the longbond (in the late 1920s, early 1930s) ? That would be much more interesting.
4. Did investors in 1929-1931, pour massive amounts of money in bonds as well ?
5. I DO see a spike in interest rates in late 1931, 1932. I, personally, think today is equal to 1931 and 1932.
I would quote mr. Charles Biderman of Trimtabs (thanks TPC !!):
1. “Flow follows performance”. And that bodes badly for the $TYX and $TNX. If the IRX breaks down then I know we’re in deep trouble.
2. “”Investors have moved $ 700 bln. from CDs and money market funds and poured that money into bond(-fund)s”". So, when that money starts to move out of bonds then we could see a REAL disaster in the markets. And that pushes up yields as well.
“So what happened back in the 30′s?”
We are not in the 30′s. There is absolutely no comparison as far as
A)currency and B)the Bond market.
To day the Federal Reserve can print and provide trillions of dollars in asset and or debt guarantees. “It can loan money with absolutly no limit to any bank or financial institution buying toxic assets,”, “We have FDIC insuring all bank deposits up to $250,000.” They even changed some institutions charters to alow them guaranties, we have safety nets, healt and pention plan that can not even be funded from taxes.
It is clear as can be that helicopter Ben Bernanke will not do the same mistakes as in the 30′s. He will soon need a very big helicopter.
Not the same mistakes will definitively give a different result.
Not necessary good but different.
When bonds don’t need to pay a return or have to be safe to move up. The return as been on the price.
Bonne chance with that.
I agree Cullen’s “points” are meritless. The 1930′s saw stocks dive 89% and GDP drop 50%…
We are in a slight hiccup that is only centered on real estate and banking. Yes, outsourcing has crushed jobs, but we could have spent that porkulus money on getting small business going and hiring instead of putting money in the hands of the rich.
If you think stocks will rise from here, bonds are going to fall… If you think bonds will rise, then stocks will fall… If this is the great depression 2 then stocks need to fall another 70% or so from here…
At that point I will be in the bonds are not in a bubble camp… Till then the currency debasement is the worry that will erode bond buyers purchasing power — if the dollar falls versus grains for example, you are losing money in your crowded bond trade.
“”Slight hiccup”" ??? No way !!!
I am bemused watching people do analysis with data from the 1930s. As if any data from a time of silent film is accurate. How do you think they did these surveys…sampling errors of epic proportion anyone?
Might as well stick a fin ger in the air and plug in your own number…as if GDP was measured accurately in any year pre computer.
“GDP was measured accurately in any year pre computer.”
In those days they did not know how and to day they are creative.