Thursday, October 27, 2016

Are We In A Massive Bond Bubble?

Today we are going to explore the possibilities that we might have just witnessed the beginning of a massive bubble in bonds, and more specifically in government bonds. I alluded to this fact in last weeks MAD Weekly Economic Review.

Now a bond bubble actually works in reverse, especially the way it looks on a chart. For more info see my Bond Basics article. In bonds when the yield is falling those with higher yielding bonds normally receive a bump up in the value of their higher yield bonds which can be cashed in for a capital gain. When yields are rising investors holding lower yielding bonds experience losses as the value of their bonds decline since new bonds can be purchased at a higher interest rate.

Readers with a good memory might recall when
the US 10 Year Treasury hit an all time low in July. As you can see since then yields have risen from  1.32% to 1.85%. That might not seem like a lot but it's a 40% move in roughly 4 months.

 So let's take a look at the longest dated charts I could gather from the St. Louis Federal Reserve FRED System. Here we can see the US 10 Year Treasury has been in a historic downtrend since the 1980's when it hit a high of 15.32% in Septpember 1981. The current low is even lower than the rate seen in the 1950's when it had trouble breaking below 2%.

We see a similar pattern in the 30 year Treasury Bond.

What about international bonds?  We can see here that Germany is also experiencing the same general trend.  While the charts below do not fully show the negative interest rates experienced over the summer, you can read my articles when I highlighted this phenomenon here and here.

In what is probably my favorite chart since it goes back to the 1750's we can see the trend exists in the United Kingdom too.


We can see this same general downtrend in just about every major developed nation with each country hitting their respective peak sometime in the 1970's to 1980's so it's not isolated to a specific continent or country. The same trend holds true for Italy, Japan, and Australia
  Japan Government Bonds Australian Government Bonds This trend is not isolated to the public sector. As many bond investors are aware the private sector is experiencing the same trend. But after falling so low, and rates negative in some countries it seems foolish to say the longer term direction can only be up from here.  If that ends up being the case we will have witnessed this bubble popping first hand beginning in 2016. 

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