MORE BUBBLE TALK
It’s becoming increasingly popular to describe the U.S. government bond market as a “bubble”. As I’ve previously explained, this strikes me as totally nonsensical for several reasons – the primary reason being that the term simply is not applicable to an asset in which you receive your entire principle back at maturity. The term “bubble” implies a grossly mispriced asset that is susceptible to substantial losses. If the instrument is used as intended there should be little to no risk of principal loss in a U.S. government bond. And given the weak economy and constant need for government intervention it is no surprise that investors are seeking a safe haven such as bonds.
Aside from all that, Credit Suisse recently published an interesting piece of research arguing the same point – that the U.S. bond market is not a bubble. They noted that the price action in government bonds is very different from historical bubbles:
“We note that the price action of bonds it is very different from the bubbles in other asset classes we have seen over the last 30 years. The six-month US bond return is 1.9 standard deviations above norm, compared to an average of 5.9 standard deviations during previous bubbles.”
So you can see the price action is not even remotely similar to the great bubbles in history. If investors continue to use government bonds as they are intended (for instance, don’t make a 10 year loan with the intention of demanding your money back in 10 minutes), diversify across bond markets and generally allocate bonds as they are intended (as a hedge against other higher risk assets) then there should be very little risk of you ever experiencing a catastrophic loss such as those seen after many of the great bubbles of the last 30 years.
Can the Treasury default ? Where do bonds come from ? Do they have the full faith of the US Treas behind them ? Can the US taxpayer pay the ever increasing debt being printed as bonds ? Are bonds debt? What is the sustainable limit of this debt ? Has the Gov’t become a debt addict ? having lead the American people down the same path with ZIRP , aka the Pusher has become the Addict.
Debt Bubble to be certain !!! And Bonds to keep the Debt Ponzi going .
Article totally ignores the DEBT issue !!
I’ve covered that pretty thoroughly here. Are you a new reader?
No, the US practices both a policy of fiscal *and* monetary policy. In other words, we could always just print more money thus devaluing our currency, bet paying off our debt in real terms while disregarding their nominal value.
The federal government, through the treasury, issues these bonds. There are other forms of bonds (i.e. municipal bonds), but I don’t think discussing them is of much value when talking about the federal government defaulting.
Not just of the treasury, but also the backing of the Fed. There have been few cases in history where a government has willing (versus unwillingly which would have been the case in Greece) defaulted on its debt. In other words, it could have simply printed more money but chose not to. Off the top of my head, some countries are Mexico and Argentina. The problem with defaulting is that you lose all credibility. Go ahead and try selling off debt after declaring yourself unable to pay off your preexisting debt.
It’s not so much a question of whether or not the US taxpayer can pay off the debt, but whether or not the US taxpayer can absorb the potential inflation if the government decided to print money to repay the debt.
Yes.
Good question. Who’s opinion do you want? That of a republican or a democrat? In all honesty, it’s a guessing game that involves a whole lot of game theory. Rephrase your question to sound something like “until what point will our debtors have faith in us being able to pay off our debt?” and you’ll see why.
The US government cannot repay its debts, at least not in real terms. Does that qualify as a bubble? maybe not, but it certainly a bad bet.
Shrek,
You “receive your entire principle back at maturity” IN NOMINAL TERMS! After the FED & C. hyperinflated the hell out of it. Good luck with that. I sense that buying gold & silver like there is no tomorrow for the dollar (like it is) is a more sensible move.
We’ve been hearing the hyperinflation story in bond circles for a decade now. At worst we’ll likely see 5-6% interest rates when the economy recovers in which case any other risk assets you own will more than offset any real losses you experience in bonds.
the “bubble” talk TPC is addressing has to do with INTEREST RATE RISK, not credit risk.
there’s plenty of other articles where credit risk is addressed.
First 3 posters: pls read more carefully.
Also, the current Here’s a currency war.
should provide a constant bid to the market as other nations attempt to devalue their currency in relation to the USD.
2 Issues:
If you are a Bond Trader (less than 2-3yr holding period) then you might consider a Gold (hedge) or Currency (hedge) to offset to devaluation of the USDollar.
If you are a Long Term Investors (more than 3yrs) the overall return on LT Bonds are not compelling at current rates –Current inflation 1% and 30yr Bond at 3.5–”Where’s the Beef”
At normal Interest Rates–sometime in the future in a galaxy far far away
Bonds will be the perfect “Risk Reduction strategery”
I believe another reason that it is incorrect to call bond market gains “a bubble” is the mania of the crowd that accompanies a bubble is simply not there.
When an asset reaches a bubble stage, investors view the asset as their ticket to wealth. The crowd mentality is that “we can all become rich” off this one asset. It’s a no lose lottery ticket. Investors don’t buy bonds to get rich and retire early.
Now gold, that’s another story. If there is any one asset that has the potential to become a bubble, I would think gold could be it.
As long as POMO is in full-swing at the Fed, gold will continue to creep higher based on uncertainty surrounding US monetary policy…IMO.
I would actually be interested to see the CS chart TPC posted with Gold in the current market…..how many Std Devs over normal has the last 12 months been?
The examples that are given are only of the extreme kind. If you are right then there was no “bubble” in risk assets in 2007 whether housing, stocks or commodities. Therefore there was no problem with the Fed’s ultra-low interest rate policy since there weren’t any “bubbles” created and I suppose you also support ZIRP.
Realistically, bubbles should be price levels significantly above the norm. For housing that would price to buyer income levels, and for bonds rates to historical rate levels. An increase in rates for 30 year bonds to what they were 10 years ago would cause a 50% decline in value, housing by comparison has dropped only about 30%.
The whole point is that you won’t lose 50% if you hold to maturity. Sure, you might lost 50% in opportunity cost, but you won’t actually lose money. I think that’s the point he’s trying to make about the bond market. You can’t call it a “bubble”. It just doesn’t make sense.
In fact, you’re guaranteed to make money in nominal terms in bonds. If that’s a bubble then sign me up. Compared to losing 90% in Nasdaq in 3 years I’d love to buy 3 year bonds and lose a few % points in real terms.
Your housing example actually proves my point about how ridiculous this argument is. People bought 30 year mortgages knowing they probably couldn’t pay it. If you don’t have 30 years to hang onto your bonds then don’t buy them. That is what a debt instrument is. It’s a loan. An agreement that you will lend someone money for a finite period of time at which point you will receive your principle back. It is utterly baffling why someone would take a 30 year bond and compare it to a 12 month collapse in other assets. That makes zero sense. If you’re concerned about duration you should reduce it. If you are trading these things then you have to recognize the risks involved and know that you are not adhering to the rules of the instrument. That’s a risk you are willingly accepting.
Comparing a 30 year bond to a 12 month bust in equities is apples and oranges. But you’re doing it because if you hone in on this one very extreme example (and ignore the reality of what a bond investor actually does) your point then holds some water.
“not applicable to an asset in which you receive your entire principle back at maturity”
There are two ways for Government to pay back at maturity and one of them is out of the question.
The problem with “your entire principle back at maturity” is that government never pays back in constant dollars. No one know what the monetary policy will be in five years. Every time government raised there borrowing substantially inflation followed. Look back as far as 250 years. Who would have said in the 60-s that rates would reach 20% in 1980-81. Who would have said a magician would come and take them they down to 0%.
It’s not only the interest rates that a bond buyer is speculating on it’s mostly the currency he will get back in 10, 20 or 30 years.
If you have a 30 year bond maturing to day should you be happy that you now need need $2.65 to purchase the same thing that you could with each dollar you have invested in that Government bond?
There are two ways for Government to pay back at maturity.
A)They could pay you back. Forget that.
If I borrow a dozen eggs from you, you will expect to get the same in return.
Why on earth would they not what they always do. Governments rarely if ever pay back unless they do not have there own currency or if they borrow in a different currency then the one they can print. In such a case they end up in trouble unless they borrowed from a country that is as irresponsible or worst than they are.
If in the short term we do have deflation,of course money would have more buying power but is it worth putting money in bonds to get such a dismal after tax return?
If history is any guide dont expect the government to pay you back in the same buying power currency that you paid them.
It never happened and never will. That is exactly why they do not default. They default you instead.
Alternatively, you could buy bond funds, which have been doing very well lately. Add some GLD, cherry pick some solid dividend-paying stocks, and you’ve got a pretty decent portfolio right there.
What folks don’t realize is that the Fed controls the interest rate through the FFR and the yield curve though bond purchases/sales. The Fed has infinite resources at its disposal for this purpose since this is a monetary operation rather than a fiscal one. The Fed can put bond yields where it wants them and that, of course, affect bond prices. The idea that the market can trump the Fed’s resources to effect its rate and yield policy is misplaced.
“don’t make a 10 year loan with the intention of demanding your money back in 10 minutes”. Certainly cannot deny this point. But what about 1,2,3 years…would you buy a 10-y treasury with the intention to hold it for 3 years? What do you do if you are fed up with 2.5% return in 3 years from now?
TPC’s argument makes only sense if you intend to hold until maturity. I am willing to bet, the majority of today’s bond investors are not in for the long run….they see bonds as a safe haven to “park” their money. Once equity markets stabilize, people will flee the bond market with its awfully low returns and seek higher yielding equities. Don’t know when it will happen but it will and that reversal will be BIG and hurt bond investors that can not afford to wait and clip their 2.5% coupons for 10 years.
“The Fed has infinite resources at its disposal for this purpose since this is a monetary operation.” So did the Romans.
Absorbing $1.4 trillion in annual deficits year after year will eventually change the meaning of infinite resources.
So far sub rates worked for japan as it had a very strong saving rate and it is a serious net exporter of goods. The US Government can not finance its expenses indefinitely from with in with out eventually resorting to monetary expansion.
That is when the tide will change. The Bond funds are accumulating as subscriptions increase every months. Bond funds do not mature and there portfolios are all trading at a premium to maturities.
US GOVERNMENT BONDS ARE IN A MASSIVE BUBBLE!!!!!!!!!!!!!!
THIS MARKET IS BEING MANIPULATED AND ARTIFICIALLY SUPPORTED BY THE MONEY-CREATION OF THE FEDERAL RESERVE. TAKE ‘QE’ OUT OF THE EQUATION AND WE’LL SEE WHERE RATES GO!
WAKE UP BROTHERS, SMELL THE RAT.
THE US IS BROKE, INSOLVENT. THE FED IS BUYING HUGE AMOUNTS OF TREASURIES BY CREATING MONEY OUT OF THIN AIR. YOU CAN THIS A MARKET!?
YOU CALL THIS A MARKET!?
Well I don’t know anyone in real life (not online) that owns any gold or silver, and I know only 5 that are in a bond fund so I still say equities are a bubble!
That’s an interesting thought GYSC. I would venture to guess that your experience is probably true for most people. We know lots of people who own equities, a few who own bonds and very few who own gold.
Well my circle is not Wall Streety or even very investment geared. Scientist in a biotech/pharam setting with 30 year old plus pros for the most part around me. All have a house (many bought in 2004-2007, ouch!), the 401k (all equities), and maybe a small trading account for buying the go-go stocks like AAPL and BIDU. No one has metals, and only 5 folks have bonds because their investment advisor put 5% of their portfolio in them.
Of course, a bubble CAN happen when not everyone is in on something but bonds and metals would have to be the smallest bubble ever.
Not meaning to sound ignorant, but…
When folks discuss the bubble in “the bond market”, does it mean largely the market in US treasury notes?
There are corporate bonds too, some of which pay substantially more than the UST notes.
I’m holding a few that pay 8%, which I bought at a 25% discount, B rated, mature in 5 yrs, yield about 12%.
Seemed like a prudent risk, for the return.
Not quite sure how they fit into this bubble talk.
“I’m holding a few that pay 8%, which I bought at a 25% discount, B rated, mature in 5 yrs, yield about 12%.” looks like a Smart move Roger Ingalls.
Ratings are a joke so make sure they have the returns necessary to make those payments.