The end of the bond bubble? It's all about China

Mar 22, 2012, 03:45

Merryn Somerset Webb

Posted byMerryn Somerset Webb

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Is the great US bond bubble coming to an end? Could be. There has been no shortage of people warning that this day would come. Type “end of bond bubble” into your search engine and you’ll see plenty of predictions (many printed in Moneyweek).

Last year, they began to look more credible - Jim Grant called his October newsletter “The Death of Bonds” and back in mid-December, Halkin Services reported Ross Clark of Institutional Advisors noting that bond prices had “reached exhaustion levels”. It took another few months for these calls to be validated but here we are: “elite government bond markets have finally come a cropper”.

Last week, as Halkin puts it, “benchmark bond prices that had appeared well supported in a tight trading range were suddenly unsupported in a wide trading range.”

What caused the shift? It might be worries about the lack of new quantitative easing (QE) in the US; it might be the news that the US ran a $232bn budget deficit in February; or perhaps it is something to do with the wave of good news sweeping the US economy. After all, if deflation isn’t the biggest risk out there, and if US nominal growth is knocking around 4%, who wants to be holding ten-year bonds offering a yield of under 2%?

But it might also be something to do with China. I spoke to CLSA’s Russell Napier yesterday and he pointed out that in the second half of last year, China made its “largest ever sales of Treasuries, ending an 18-year-era of mass printing of undervalued renminbi and a massive distortion to the US-dollar yield curve”.

In December alone, China sold at least $20bn in US Treasuries. From the end of 2007 to the summer of 2011, foreign central banks bought around 45% of Treasury issuance (so something in the region of $2.2trn). Since then, they have been not buying but liquidating - something that clearly affects demand, and then yields.

It also means that someone else is going to have to start financing the US (savers?). And most importantly of all, it represents the beginning of a very major shift in post-crisis global rebalancing. I’ll return to this in more detail next week.

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  • 1. Shinsei1967

    (22 March 2012, 07:31PM)  Complain about this comment

    "Type “end of bond bubble” into your search engine and you’ll see plenty of predictions (many printed in Moneyweek)."

    Really ? I recall plenty of three page articles from James Ferguson saying to keep buying bonds.

    2.5% yields in UK look cheaply historically but as James F keeps saying nothing to stop them going to Japanese sub 2% or sub 1.5% yields.

  • 2. Van

    (23 March 2012, 08:03AM)  Complain about this comment

    Japan is still a big exporter. think what that means when it comes to the value of the Yen and what lenders will get back on their bonds; now consider the opposite case, the effect on the currency and whether lenders will get back in this case.

  • 3. Rob

    (23 March 2012, 04:18PM)  Complain about this comment

    More QE is on its way. US needs to issue +/- $1.3 trillion of new debt a year (much more if fiscal deficit carries on over $200 billion / month). Last year the Fed bought around $750 billion until QE2 stopped. That's getting on for two thirds of new issuance.
    US has had a lucky break recently, offsetting China's pull back, as portfolio managers were panicked by eurozone situation and also EM stock markets last year. They fled to "safety". If either these flows reverse (shift back into risk assets) or even if the rate of new buying ceases to keep up pace there won't be enough buyers of US treasuries.
    Result: yields rise to market clearing levels or more Fed QE. I expect latter.

  • 4. goldbull

    (25 March 2012, 10:40PM)  Complain about this comment

    All the talk of a US Recovery is pure pipe dream. There will be more 'overt' QE without a shadow of a doubt. The alternative is unimaginable crippling defaults and deflation but every step of the way Helicopter Ben has shown he prefers hyperinflation.

  • 5. Merryn

    (26 March 2012, 10:29AM)  Complain about this comment

    @Shinsei67 James had been very much a bond bull and he has been right. But we don't all always agree and other writers - Tim Price for example - have regularly cautioned readers against going anywhere near US/UK sovereign bonds.

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