Will the bond market be the next shoe to drop?
Posted on 18 May 2008 with no comments from readers
US and UK house prices are falling and there is a banking crisis. I am also worried about equity prices as profit forecasts are way too high. But the more immediate problem may be the bond market where prices anticipate falling interest rates that just may not be realistic or obtainable now that inflation is out of the bag.
Dr. Marc Faber says he thinks bonds are likely to be the worst possible investment in 30 years. His argument is that inflation will destroy the value of money and that interest rates being paid on bonds are far too low to compensate.
You can also see it as a reversal of the recent bull market for bonds which has pushed prices down and down. Who could sensibly buy US treasuries at current ultra-low interest rates? Do investors not realize that treasuries are re-priced as interest rates rise and so capital can be lost?
How can we be so sure inflation will increase? You just have to look at Fed policy which is monetary easing on a heroic scale to bail out the US banks and home owners. The nasty side effect of a monetary explosion is inflation. That is why oil is spiking to $128 a barrel. It has precious little to do with the Saudis sitting on oil supplies which they are not.
If you shove a massive amount of new money into the system then you get inflation. This is how inflation occurs. The last time the US had this problem was in the 1970s and it took Paul Volcker at the Fed and big interest rates increases to knock inflation down. Between 1978 and 1982 he managed to get rid of inflation but only with high interest rates and a recession – and an oil and gold price spike in 1979-80.
Is the US economy now too weak to take this nasty medicine? I wonder but the markets may do the Fed’s work for it by keeping interest rates far above base rates. That is what we are seeing.
Eventually will we not see bond holders abandon their low interest rate positions and head for higher yield currencies or inflation hedges like gold and silver? And like any shift in financial markets this is likely to be a sudden exit, although it has probably already started.
no Comments posted by readers:
The real problem starts when foreign purchasers of US bonds refuse to finance further US profligacies.
Long Interest rates through the roof, and prices through the floor.
Depression in US, exported to UK and rest of Europe.
Further real estate price falls in US/UK, more bank failures, more western nation socialisation of banksters losses.
Top blow off on commodities, (but food?) – global bust.
Real estate bust spreads to middle-east golden miles.
Pensions (state and private)destroyed.
What chance US invades Iran, Venezuela, Canada, last desperate fling?
Survivors? Russia, Canada, Kazakhstan, Ukraine, Brazil, – all bets off if war!!!
ah yes the forgotten bond market, like the forgotten deficits the UK needs to finance, the dirty little secret that no-one talks about. this goes too deep of course, it implies a complete about face of the service economy to one that produces and creates. we’re living on borrowed time indeed, but who understands or appreciates our dillema? the bond market does but hardly anyone else, this is a democracy and we will get back on track once we understand and value the fundamentals to the debate until then confusion reigns
The boomers are screwed