For reasons unknown to me some financial reporters like to talk about a US bond market meltdown. However, as the charts show the recent spike in yields can be hardly considered a meltdown. Actually, yields are still on a very strong downtrend and there is the possibility that if the recovery falters to get down to 1% in the case of the 10-Year Note. As far as quantitative easing is concerned, in my opinion all the talk about when it will end is a distracting issue because it will be with us for a long time.
Quantitative easing is the new tool of exercising monetary policy in an environment of a destabilized worldwide banking system. The bifurcation that caused the destabilization of the system in 2008 triggered many fast but also slow modes related to deflationary pressures that will take many years to decay. System theorists know what I am talking about but for all others the idea is that it takes time for the dust to settle and maybe we are talking about 10 to 20 years. Since the financial crisis erupted already 5 years have passed and things are only marginally better in the US but are getting worse in Europe and for the BRICs. Those that do not like Bernanke for his QE policy and want him replaced will maybe have to live with someone else who will be forced to continue pulling the trigger on asset purchases for several years to come unless something spectacular happens and there is solid world economic growth and a stabilization of the banking system.
Now, the spike in the 10-Year Note yield from the lows is far from a meltdown. As the chart below shows, yields are well within their down-channel and on a downtrend:
Why would anyone want to call a typical spike (a.k.a “dead cat bounce” in technical analysis) in a severe downtrend a meltdown? I can think of several reason for that but they are not important. The fact is that a rise in yields makes bonds cheaper and if the outlook for the economy is not all that good it makes bonds more attractive to portfolio managers. Below are three major events that may cause a flight to quality in the near future:
1. A breakup of the Euro (highly possible in my opinion and inevitable down the road)
2. Chinese debt crisis
3. Emerging market debt defaults (possibly multiple)
These are serious considerations and no hype of the form “we are having a bond market meltdown” can cause a portfolio manager to overlook, sell bonds and buy stocks. The fact that a few speculators made money recently shorting bonds cannot compensate for the high bond gains of 2011, for example, and more importantly for the fact that yields have been going down in the last 20 years as shown by the down-channel on the above chart. Therefore, I would be very careful to declare that bonds are in a bear market at this point, or even worse in a meltdown, at least before the 10-Year Note yield challenges again its recent highs and moves above 3%.
Disclosure: no relevant positions
Charting program: Amibroker