Bonds, Lame Bonds

Bonds, Lame Bonds

The most important story in finance was hardly mentioned in the popular press, but Bloomberg is on the case: ‘Global Bonds Tumble into Their First Bear Market in a Generation’:

Under pressure from central bankers determined to quash inflation even at the cost of a recession, global bonds slumped into their first bear market in a generation.

The Bloomberg Global Aggregate Total Return Index of government and investment-grade corporate bonds has fallen more than 20% below its 2021 peak, the biggest drawdown since its 1990 inception…

Soaring inflation and the steep interest-rate hikes deployed by policy makers in response have brought to an end a four-decade bull market in bonds. That’s creating a particularly difficult environment for investors this year, with bonds and stocks sinking in tandem. 

‘…Bloomberg’s bond gauge is down 16% in 2022, while MSCI Inc.’s index of global stocks has seen a larger decline.

Readers are reminded that we play the long game here. We have no idea what stocks will do tomorrow…nor can our guesses about tomorrow’s inflation be relied upon.

Instead, we just try to ‘connect the dots’ in order to understand what’s going on. We look for the Primary Trend…the deep tide beneath the waves…the one that will raise our boats for many years — or sink them.

Here is what we see:

The stock market topped out in December 2021, with the Dow at more than 36,000.

The bond market topped out in the summer of 2020, with the yield on the 10-year Treasury well below 1%.

This is not just a pause in the Bull Market of the last four decades; it marks a new Primary Trend.

A 700-year drop

Bonds — and the interest rates they reveal — tell us which way the strong undercurrents are running. They measure (indirectly) how much capital is available and (directly) how much it costs. A place like Switzerland, with abundant savings and reliable borrowers, typically enjoys low interest rates. A West Baltimore ‘payday loan’ joint or a poor country such as Haiti or Burkina Faso will have much higher rates because there is less capital available…and borrowers might not pay it back. And generally, as the world grew richer, interest rates went down. Paul Schmelzing, at the Bank of England, showed them falling for the last 700 years.

But the Fed got up to mischief 20 years ago — dropping its key rate from above 6% to below 1%. Was the country suddenly richer? Were savings more abundant?

Of course not. The Fed was giving out a lie. What’s important about interest rates is not that they are high or low, but that they are honest. And the Fed was manipulating credit prices in order to give the impression that we were richer than we really were. The idea was to boost stock prices, increase spending, and stimulate the economy. Then in 2008, it repeated the scam, pushing rates down to ‘effectively zero’. In real terms, adjusted for inflation, the Fed Funds rate stayed below zero for more than a decade — where it remains still.

No wonder speculators acted as though money had no value — bidding up prices of meme stocks and cryptos to preposterous levels. No wonder businesses borrowed to buy back their overpriced shares. And no wonder the US Government spent trillions on unwinnable wars abroad and jackass boondoggles at home.

And no wonder the country now has US$90 trillion of debt — public and private — so much that the pain of reducing inflation will now be likely more than the elite can stand. In order to stop inflation, the Fed must raise interest rates. And every 1% increase — if applied to the whole debt load — would add US$900 billion in extra expense annually.

Dow below 20,000?

Alert readers will wonder: where does the money go? If debtors pay out an additional US$900 billion, creditors must take in an additional US$900 billion. The economy has lost not a single penny, right?

Not exactly. As interest rates rise, fewer people borrow, and more existing credits are cancelled or go bad. Our monetary system is based on credit; a decline in the amount of credit outstanding is the same as a contraction in the money supply…

…so, a decline in the bond market tells us that the tide of credit, on which the whole economy — real and fake — floats, is going out.

Already, the Dow boats are down 15%. The 10-year Treasury bond yield has more than quadrupled from its 2020 low. And mortgage rates have doubled.

But these are, so far, just mild corrections. If this is the Primary Trend we think it is, it may take us all the way down to where the last one began — in 1980. If so…

The Dow will keep dropping…down below 20,000.

Bonds will be crushed. Low coupon bonds will again be regarded as ‘certificates of guaranteed confiscation’ as they were in the ‘70s.

Mortgage rates will shoot up to more than 18%.

And the US — economically and politically — will turn into a quivering jelly of confusion and despair.

We remind readers too of a Bonner dictum: the force of a correction is equal and opposite to the claptrap that preceded it. By that alone, the developing Primary Trend should be one for the record books.


Dan Denning Signature

Bill Bonner,
For The Daily Reckoning Australia

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