The uproar in the bond markets has raised a common question in recent years: Is the four-decade bond boom coming to an end?
The bears point to extraordinary levels of money printing and huge government deficits.
But the bond advocates remain adamant.
The economics of rate cycles is confusing.
And history offers little guidance except to suggest that when the market turns, most investors are caught off guard.
How could it be any other way?
In the past year, the United States has witnessed the fastest growth in money supply and produced the largest fiscal deficit since World War II.
The Fed has doubled its balance sheet, and this is joined by the public stimulus plan since the Fed itself has promised to buy 120,000 million dollars in securities per month.
Commodity markets are going out of business.
Inflation differentials have widened.
The bears suggest that returns will rise as globalization reverses.
The rapid expansion of international trade in recent decades, they argue, has pushed down wages, inflation and rates.
Globalization was already receding before the pandemic produced its own supply shock.
In the coming years, China's workforce will shrink and populist pressures against free trade are likely to persist.
As Beijing stops exporting deflation, long-term rates will rise.
Bond lovers don't see any of that.
Aging promotes deflation, not inflation, they say (see Japan).
Furthermore, massive government loans during the pandemic are only an addition to an existing pile of nonperforming debt, the impact of which is also deflationary.
Any momentum induced by Biden's spending plan will be short-lived.
It is not an environment, they point out, in which inflation can take off.
The differences between the two sides are difficult to resolve.
Centuries of history do not show a clear relationship between the level of government debt and bond yields.
The impact of demographics or economic growth on rates is also unclear.
The US population and economy expanded rapidly in the late 1800s as rates fell, and rose after 1945, when bond returns tended to rise.
Inflation may be a monetary phenomenon, as Milton Friedman claimed, but after 2008, it stood still and bond returns bottomed out despite relentless money printing.
As for globalization, world trade and rates both plummeted during the Great Depression.
Raging fixed income markets last for decades, and anyone bold or reckless enough to predict their demise usually ends up with their tail between their legs.
The corollary is that investors are surprised when rates change course.
"The prevailing opinion never shows the future course of [bond] prices, but only explains their current position," wrote economist John Burr Williams in his 1938 classic
The Theory of Investment Value
.
Williams cited an 1899 poll of leading figures on Wall Street and Washington.
Asked about the future direction of rates, none of these luminaries predicted that the bullish bond market, which lasted decades, was ending.
They had not taken into account, the book suggests, the recent discoveries of gold in South Africa and the new mining methods that were producing an increase in the monetary base.
After 1900, commodity prices and bond returns rose for 20 years in a row, after which they fell for another quarter century.
The turning point came in 1946.
During the war, short-term rates were below 0.5% on Treasury orders and 30-year returns were capped at 2.5%.
To help finance the war effort, the Fed purchased bonds directly from the government.
War restrictions suppressed consumption and encouraged savings.
Believing that rates would never return to prewar levels, bond buyers pushed long-term returns below 2% for the first time in history.
The
timing
couldn't be worse.
The end of the conflict released the Fed's excess liquidity and stifled consumer demand, driving inflation to double digits.
But Washington kept rates at a minimum.
The great bear market for bonds began in April 1946. In three and a half decades, an investment in 30-year bonds, held to constant maturity, lost more than four-fifths of its value.
British Consols (perpetual bonds) lost 97% of their purchasing power.
In the late 1970s, government bonds were reviled as "certificates of confiscation."
The "war" against Covid has a lot in common.
The US public debt is back at war levels.
The Fed is helping out by buying bonds.
Anti-pandemic policies have suppressed consumption and boosted savings.
The monetary authorities are determined to keep rates ultra-low even when inflation picks up.
And investors can't believe that low bond returns won't last forever.
The current bull market began in 1981. No previous cycle lasted as long, nor witnessed such an impressive decline in returns.
“The tendency to go to extremes,” write Sidney Homer and Richard Sylla in
History of Interest Rates
, “is often seen at the highs or lows of a prolonged trend.
At such times, precedents and overwhelming psychological expectations reinforce the prevailing economic factors. ”
This time it is no different.
Not only have bonds traded at highs in the last year, but the term premium - the extra payment that bondholders normally demand as compensation for uncertainty about the future course of rates - has turned negative.
The recent extremes, coupled with holder and central bank complacency, are the strongest indicator that the largest bond bull market in history has far passed its expiration date.
The authors are columnists for
Reuters Breakingviews
.
Opinions are yours.
The translation, by Carlos Gómez Abajo, is the responsibility of
CincoDías