donderdag 17 januari 2013

U.S. Bond Market About to Implode

I just wanted to give an update on the status of the U.S. treasury market. I warned about a bond bubble here, stating that short interest in the commercials was going up dramatically. The last months we have seen weakness in the bond market as a result, but if you think it's already over, I have to disappoint you.

The bond bubble collapse hasn't even started yet. On Chart 1 we can see that since that article, the net short positions for the commercials has even gone up (pointing to a weak bond market and a bottoming out of yields), and the non-commercials have kept buying more and more bonds, thinking it would be a good investment. If these non-commercials unwind their long positions, we will start to see the real bond bubble collapse.
Chart 1: Commercial Open Interest in Treasury Notes
Even though non-commercials are buying like crazy, the yields haven't gone down. On Chart 2 we see that yields have risen even when long positions in non-commercials went up. This is not a normal event.

Chart 2: 10 year U.S. bond yields
To find out more, go here.

5 opmerkingen:

  1. Interesting prediction. Yields have risen from 1.88% to 1.95% in just a few days, the market has moved in the direction you have predicted. However, its not clear the yields will increase dramatically as you suggest.

    1. I'm sure about one thing, the USD will devalue 30% against gold and people holding treasury bonds have zero gains if they include inflation with it.

  2. You might be right if inflation there is an over supply of money in the US economy. For there to be an over supply of money (indicated by inflation taking off), the velocity of money in circulation will have to increase. Since bank lending is very weak, the velocity of money flowing through the economy is slow, even though the Fed is printing lots of it.

    There has been some asset inflation (in agricultural land, for instance), but house prices are still weak in the US, so gold is unlikely to increase in value as quickly as you suggest, because American's are more likely to invest in housing (i.e. something they can use) before decide to switch their wealth to a hedge against inflation such a s gold. Until house price inflation does take off, the USD may devalue, but gold will not go up in value by much.

    Rather, the Zero Interest Rate Policy is likely to ensure bond prices remain relatively high for some time, as the Fed is trying to encourage consumers to buy housing and increase employment by doing so.

    1. The velocity of money is GDP/Money. GDP is weak and will remain zero. Money will increase dramatically. So indeed velocity will be low.

      That means treasuries will have low yields as far as the eye can see.

      But you didn't account for the currency devaluation due to the increase in money supply. And that's the real inflation. That's about 30% per year at the current pace of money printing. Without money printing it's at least 8% a year.

      Gold always follows the M1 money supply.

  3. That is an interesting point about currrency devaluation leading to higher inflation. If you are right, gold will move up above its current level, at around $1,678 per ounce.

    My theory is that gold won't increase my much, if at all. Real inflation happens when the cost of real assets that people use starts to go up, and there is no evidence that a 30% increase in the money supply will not result in a 30% increase in house prices. Until house prices must start moving up, there is no evidence of inflation creaping up, and the price of gold will remain subdued as GDP improves.

    There is one joker in the pack: oil prices. If you are right about the relationship between the increasing money supply, currency devaluation and rising asset inflation, higher oil prices (and to a lesser extent, copper prices) could be push inflation higher. Oil is expensive right now, so if its price increases by 30% from $116 to $150 per barrel, investors would be forced to switch to gold as hedge against inflation.

    However, I don't think the Fed's policy of printing money is leading directly to currency devaluation, higher inflation or higher gold prices. Capital inflows are likely to ensure that that the dollar does not go into meltdown and decline in value relative to gold by 30%. Since printing more money does not lead directly to asset inflation, gold is not going to jump 30% to $2,100 anytime soon.