Saturday, January 10, 2009

The Debts of the Spenders: Has the Bond Bubble Burst?

I think Treasuries have one more leg up before the inevitable rise in interest rates.
But that being said, the long bond (30 year) has definitely weakened considerably since early December. The re-introduction of 3 year paper has also sparked some uncertainty among bond traders who are (rightly) concerned about wider bid ask spreads and other signs of deeper liquidity.

We are in a period of early thaw right now.

Capital flows have slowly moved into more risky assets such as private debt and muni bonds during December and early January. The relative dearth of equity buyers means that institutions remain wary of that sector and for good reason.

In the long run, inflation will return as the velocity of money begins to accelerate. Thus, long-term Treasuries should NOT be approaching Japanese-like levels of near 0% yield for decades on end. Please note that accelerating velocity does not necessarily equal economic growth. The gold bugs might yet have their day and see the US hit Weimar Germany hyper-inflation.

There is a limit to what the Fed can backstop. Exogenous factors like rising ag prices and simultaneous quantitative easing by VIRTUALLY EVERY SINGLE COUNTRY in the world will ruin Bernanke's plan. Remember that the BOJ's Q.E. experiment was conducted in a period where they were the only Q.E. beast.

That is not the case this time. What we are beginning to see is weakness in the G7 bond markets as supply begins to outstrip demand.

The "brave" money is flowing into emerging market govt debt because they have the highest interest rates (a relic of 2005-2008 inflation) and therefore the biggest room to run in terms of capital appreciation.