Did The 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. 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!

I don't understand it much myself. But I followed the link in the last paragraph referring to inflation and I have to disagree with some of his conclusions.

In order for inflation to make a meaningful negative impact you must FIRST get a recovery. In other words, the private sector balance sheet must heal to the point where they want to take on more debt.

I think he is making some errors in correlating now to the 30s. He is omitting significant variables existing now that did not exit then.

First off, his claim that we don't have inflation is pure bunk. We may have "officially" low inflation, but in the real world we got inflation. The government simply redefines inflation as it needs to keep the numbers where it wants them. I just got a 25% increase in my monthly charge from Louisville Gas for the months I use no gas. I pay a meter fee every month. It is the same regardless of whether I use gas or not. It went up 25% this month. Does the government consider this to be inflation? How about 20% increase in county property tax rates? The value of my house doesn't increase so they raise my rates and my bill goes up. Is that inflation? The magical games they use to compute food inflation are simply Alice in Looking Glass Land math. A number means what they want it to mean on the day they use it.

He makes the case that the debt to GDP was 120% then. But he neglects to point out at that time the government was not looking at trillions of unfunded liabilities down the road. He forgets that right now the capital markets are tapped out, sucked dry by government spending of borrowed money. The money that is available for the private sector to borrow is funny money. Just printed, ink still wet.

He leaves out the fact that today the government is on an anti business rampage, working hard to either take over businesses or regulate them out of existence.

I could go on and on. For every point that is analogous to the 30s and the subsequent recovery, there are 5 others that are totally different.

I don’t understand it much myself. But I followed the link in the last paragraph referring to inflation and I have to disagree with some of his conclusions.

In order for inflation to make a meaningful negative impact you must FIRST get a recovery. In other words, the private sector balance sheet must heal to the point where they want to take on more debt.

I think he is making some errors in correlating now to the 30s. He is omitting significant variables existing now that did not exit then.

I totally agree with you; inflation in gas, veggies, meat, property taxes (and the rub in Cincinnati is so many people get tax abatements to re-gentrify areas, leaving the rest of us to foot their bills erstwhile the city governments spend “stimulus” money to put in light rail and streetcars!!!)...ugh!

Interest rates aren’t going up.

LOOK
AT
JAPAN

Interest rates in the U.S. are tracking Japanese interest rates post-1989 because the U.S. is copying Japan’s stupid infrastructure spending, QE, nationalization of healthcare, and other policies.

Copy Japanese policies, get Japanese results.

Which means: Interest rates are headed much lower...and so too are salaries, stock prices, and the values of homes.

A bond’s face value is say 100 dollars. It will yield an interest of say x% at $100 and if there are a lot of buyers for bonds the price of a bond goes up and can reach for example $110 but the interest paid on them at that price goes down.

So the ‘bubble’ in bonds is their high sales value which is driven by demand. Why has there been a big demand for US Bonds? Because the banks have been borrowing from the Fed at near 0% and then turning around and buying US Bonds (likely the member banks of the Fed have been told to buy those US Bonds with the ‘free money’). The bonds bought give interest to the banks which taxpayers are on the hook for. So bond prices remain high as in a bubble range because banks use their lending capital to buy US bonds rather than lend money to individuals and businesses to bolster economic growth.

The Fed Reserve would like to keep interest rates low. so they loan practically at 0% to selected entities and likely instruct those entities to buy US Bonds and treasuries in effect keeping bond interest rates low. In a normal economy a bank will lend on mortgages at a slightly higher rate that what they get from treasuries, if the borrower is a good credit risk. But that is not happening now.

The interest yield and bond value always move in opposite direction. If a bond increase its purchase price from 100 to 110, then the yield may drop from x% to x-y%. Conversely, if the bond purchase value falls from 100 to say 90, then the interest may increase from say x% to x+z%.

So a pop in the bond ‘bubble’ may be indicated by a increase in interest paid from x% to x+z%. This article speculates that the bond bubble is in the process of popping because interest rates are up so much in the recent past.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.