The bears, Bernanke and the great bond bubble

The bond market is understandably jumpy about what Ben Bernanke says tonight but the Fed is unlikely to abandon its control of the 'biggest bond bubble' in history.

“Let’s be clear,” said Andy Haldane, the Bank of England’s director of financial stability, a week ago. Oh? Clear? When central bankers promise to be clear, everyone leans forward a little.
He went on, clearly: “We've intentionally blown the biggest government bond bubble in history.” He described this as the biggest risk to the financial system and added: “we need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.”
Bonds underpin the valuation of all assets, including equities, but things are a bit different at the moment. Bond prices are falling while share prices are rising, especially in the past few weeks.
That’s partly because bonds are in a bubble and shares are not. As a result of that, the bond market is much jumpier about what Fed chairman Ben Bernanke says tonight than the sharemarket is.
Last time he spoke Bernanke said the Fed would, “in the next few meetings”, start removing the massive monetary stimulus that has intentionally blown the biggest bond bubble in history. Tonight that phrase is likely to be repeated, with perhaps some more clarity around what it means (clarity seems to be catching).
With consecutive triple-digit rises by the Dow Jones Industrial Average, the stockmarket is betting he’ll calm things down. The bond market, meanwhile, is having a panic attack.
Private foreign owners are dumping their US treasuries and US investors in bond mutual funds are redeeming by the billion. Mortgage rates in the US, which are set by the Treasury yield rather than the cash rate, as they are here, are now rising, and the boom in mortgage refinancing has burst, with the “refinance index” falling 36 per cent since the start of May.
It’s no wonder there is a bond bubble. Can you imagine what would happen to house prices if the central bank had to buy a fixed amount – say $US85 billion – worth of houses every month?
And it’s not just that: inflation expectations have collapsed as well, despite the ballooning of money supply. All the predictions of an inflationary outbreak because of all the money printing going on have proven to be wrong – because the oversupply of labour around the world is overwhelming the impact of so much liquidity.
The stark choice now being forced on workers and unions by Australian carmaker, GM Holden – that is, cut wages or lose your jobs – is another symptom of the same thing.
US unemployment is 2 per cent higher than Australia’s – which is still too high at 5.5 per cent – so, given that, there’s unlikely to be an early start to the new bond bear market.
Many gurus are saying that the great bond bull market that started in 1981 is either ending, or has ended already, and they’re probably right. It’s just that despite the clear views of Andy Haldane this process is unlikely to be quick or disorderly: the Fed is basically in control of the market and is unlikely to let it get out of control, as it did in 1994.
Global sharemarkets have been exuberant lately because central banks are also intentionally driving investors out along the risk curve – that is, forcing them to buy riskier assets in search of better returns. That’s the background purpose of “intentionally causing the biggest bond bubble in history”.
Australia’s sharemarket has underperformed because China’s economy is slowing.
That’s the trouble with aligning yourself so firmly with one country: you have to take the bad with the good. And right now the US is the good.

Alan Kohler will be hosting two Ashes lunches with Gideon Haigh and Stephen Fay (former editor of Wisden and author of books about The Bank of England and the collapse of Barings) on June 25 in Sydney and June 26 in Melbourne. To book a table click here.

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