The unsinkable bond market
Where’s that bond market bloodbath we’re all waiting for?
Bondholders are doomed, we keep hearing. Pimco’s Bill Gross last fall promised a Treasury market turkey shoot – and that was before the government declared a profligate payroll tax holiday and the political parties presented irreconcilable deficit-cutting plans.
Add political gridlock to runaway spending and you have a recipe for an imminent bond market collision with reality. If Monday’s S&P warning on U.S. debt didn’t do the trick, surely the coming dance with the debt ceiling will suffice, right?
Wrong. Though logic dictates interest rates can’t stay low forever, there are a lot of reasons to expect them to stay low at least through this year – and few reasons to listen to the doomsayers who say a rate spike is at hand.
“If there was a real concern that rates were going to spike when the government hit the debt ceiling, people would be dumping Treasuries now,” said Barry Ritholtz, a New York money manager who writes the Big Picture finance and economics blog.
Yet the prices of short-dated Treasury bills have actually risen this year, and the price of 10-year government bonds has fallen only slightly (see right). The 10-year Treasury recently yielded 3.37% — just 7 basis points above its level at the end of 2010.
Stable government bond prices don’t seem to make sense at a time when financial types are tying themselves in knots over government defaults and inflation.
But the inflation talk is early, at the very least. And while Washington is doing its best to persuade the world it can’t be trusted, we have yet to arrive at the place where our politicians are demonstrably more destructive than anyone else’s.
Unless the uncool heads unexpectedly prevail, the depressing near-term economics of the situation – weak economies, nervous investors – will keep government bond yields low for a good long while.
“The reaction to S&P shows you the market is starting to expect a weaker economy in the second half,” said Jason Pride, director of investment strategy at Glenmede, a Philadelphia-based firm that manages $19 billion in assets. “That’s going to mean more demand for Treasuries.”
The government’s budget problems are only the latest bond market scare story. As 2011 opened, the big shift that was going to force up rates was the end of the Federal Reserve’s quantitative easing program, scheduled for June.
At the time, there was hope that a tax-stimulated consumer would get the U.S. growth engine going, which would feed demand for other goods and services and lead to a rolling recovery. Investors, it was assumed, would insist on higher rates to compensate them for the risk of rising inflation.
This seemed to pave the way for a steady rise in Treasury yields. But a series of minishocks has intervened, starting with the January riots in Egypt that sent oil prices soaring and continuing through the March earthquake in Japan and the various debt scares in Europe. In each case the prices of stocks and commodities were hit, while bond markets sailed along.
The latest example came with S&P’s U.S. debt warning Monday. If anything should have unhinged the supposedly nervous holders of Treasury bonds, it should have been the rating agency’s statement that there’s a “material risk” politicians won’t get around to fixing our overspending and undertaxing problems till it’s too late.
Yet in a familiar refrain, the Dow Jones Industrial Average dropped 160 points and crude oil slipped $2 in New York and $107 — while the price of the 10-year Treasury actually rose.
Seeing this cycle play out over and over has persuaded some bond watchers that maybe the big one in the Treasury market is still off well in the distance.
“I am moving away from the yields-up point of view,” says Mark Bronzo, who runs large-cap growth funds for Security Global Investors. “It looks now like a slowdown is going to keep the lid on rates for a while.”
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