Will There Be A Bond Market Collapse

[Mikhail Liebenstein]

There have been a few topics recently where the historic role of the Bond Vigilantes has been raised.

For those who don't know, the Bond Vigilantes were the earlier 1980s Bond traders who had an almost pavlovian response to the threat of inflation. Essentially one whiff of inflation and they'd sell bonds triggering a collapse in bond prices. The effect of which is to drive yields and interest rates up.

Now as williamdb likes to point out, the original bond vigilantes have most retired and the response now seems mute.

But think about this!

All the money in US T-Bills and UK Gilts etc that is held by Sovereign wealth funds. Right now these guys are getting low yields and are facing the possibility of inflation/devaluation.

We have just witnessed capital flight from the UK, and there was a similar dose earlier in the US when the dollar originally plunged. Since then the US has recaptured its safe haven status to a degree, but for how long?

Rather like the concept of risk and risk premium has suddenly come back in fashion with equities, property and other assets.

How long do you think bond holders are going to sit holding bond that are losing them money?

The answer is not long, at which point Governments won't be able to borrow and neither will banks and so interest rates will soar.

The Bond Vigilantes are dead, long live the bond vigilantes! - Discuss

Edited February 14, 2009 by mikelivingstone

[50%deposit]

this sounds interesting, especially if it pushes interest rates up.

however, i dont really know what any of this stuff means so i cant really provide you with any intelligent return.

i guess a bond is when you loan money to Gordon Brown? and he uses it to fund wars? is that it?

[P.P.]

http://www.telegraph.co.uk/finance/comment...alls-apart.html

http://marketoracle.co.uk/Article8754.html

......Bond yields are in a move higher as you would expect, bond buyers know what the increase in market supply will do to prices if no one (in essence foreign buyers) turns up for the auctions and bond yields are acting accordingly as long positions are closed.

The Fed will end up reacting to the results of the auctions; if buyers insist on higher yields (by setting lower prices) the Fed will step in and start buying across the curve, indeed if they are looking at the yields across the curve now they may well be feeling some concern that the plan to hold rates at low levels may already be under attack.

If the Fed fails to react to higher yields or failed auctions (when not enough bids are received to cover the issuance) bond markets will take fright as the Feds credibility to back up the words from the FOMC minutes is destroyed. Without a buyer of last resort supporting the market then a bout of panic selling, even dumping could take place. In some ways this would suit the Fed as it would begin its intervention at a lower price level and if the policy is successful the balance sheet would benefit from appreciating prices as yields fall back.

............/..............

......Even if the Fed is successful and keeps interest rates along the curve artificially low, there is no guarantee that the expected result of increased inflation expectations will occur in the future. Without the future threat of inflation business and consumer spending patterns will remain "tight" and a continuing hoarding of cash and cash like assets will remain attractive, even in an environment where real interest rates are negative. Only when a point is reached when cash, held as an asset , shows a depreciation will it become viable to swap cash for other assets that will give a higher return. This is why many schemes are failing, the dollar has become an asset in its own right:

[Mikhail Liebenstein]

this sounds interesting, especially if it pushes interest rates up.

however, i dont really know what any of this stuff means so i cant really provide you with any intelligent return.

i guess a bond is when you loan money to Gordon Brown? and he uses it to fund wars? is that it?

Yes, basically correct. See: http://en.wikipedia.org/wiki/Government_bond

A bond is basically a loan (to the Government or a Company or Corporation) that pays a stream of interest also a know as a coupon (either fixed or inflation linked). As interest rates go up, the price of the bond generally has to fall, as that way the bond's yield, ie the annual coupon divided by the bond value times 100% can then rise.

So when the bond vigilantes strike, they sell bonds,forcing down the price of the bonds and thereby raising interest rates.

Edited February 13, 2009 by mikelivingstone

[Mikhail Liebenstein]

http://www.telegraph.co.uk/finance/comment...alls-apart.html

http://marketoracle.co.uk/Article8754.html

......Bond yields are in a move higher as you would expect, bond buyers know what the increase in market supply will do to prices if no one (in essence foreign buyers) turns up for the auctions and bond yields are acting accordingly as long positions are closed.

The Fed will end up reacting to the results of the auctions; if buyers insist on higher yields (by setting lower prices) the Fed will step in and start buying across the curve, indeed if they are looking at the yields across the curve now they may well be feeling some concern that the plan to hold rates at low levels may already be under attack.

<SNIP>

Of course the Government buying back bonds is kind of self defeating. Either it lowers the Government ability to spend or the Government buys said bonds back with QE money - in which case the Bond Vigilantes start selling and run for the hills.

I really do think this is going to be the next wave. Government plans are so prone to failure that is the only thing that can possibly happen - we are in a bond bubble.

[Minderbinder]

For those who don't know, the Bond Vigilantes were the earlier 1980s Bond traders who had an almost pavlovian response to the threat of inflation. Essentially one wiff of inflation and they'd sell bonds triggering a collapse in bond prices. The effect of which is to drive yields and interest rates up.

But there is no whiff of inflation. They see a deflating economy. So they buy goverment bonds for safety.

How long do you think bond holders are going to sit holding bond that are losing them money?

Until we return to an inflationary environment. In a deflationary environment there is nowhere else for them to put there money and get a decent return. Its all too risky. They will stick with government bonds. They will continue to buy a government's bonds unless they decide that particular government is in imminent danger of default.

[Authoritarian]

I don't know anything about this stuff but I'd like to have a punt if I may...

Essentially then, a few countries have amassed a vast amount of sovereign debt with low yields and they want to protect their purchasing power. If they want to liquidate these assets though the question is what are they going to do with their wealth given that holding US dollars is seen as too much of a risk.

They may look to some form of tangable wealth, but as the countries in question are generally resource rich amassing something like oil is unnecessary and there may not be enough gold available to make this a viable option either.

A sensible option would be foreign (U.S) property given that it's value cannot be inflated away and would provide a long term revenue stream.

Am I anywhere close?

Edited February 13, 2009 by chefdave

[cht]

The SWFs aren't in the position of power people think they are. The real bond vigilantes are the private fund managers with huge sums to invest wherever they see fit. Think Soros and mulitply many times over.

[Housing Bear]

But there is no whiff of inflation. They see a deflating economy. So they buy goverment bonds for safety.

Until we return to an inflationary environment. In a deflationary environment there is nowhere else for them to put there money and get a decent return. Its all too risky. They will stick with government bonds. They will continue to buy a government's bonds unless they decide that particular government is in imminent danger of default.

Long term bond holders are obviously forward looking, over the full length the length of the bond. As they see the UK economy crashing, bailouts not working, banks basically bankrupt, and lowering interest rates having no effect whatever, bond holders are obviously worried about the government's only last bullet - Quantitative Easing - which is VERY inflationary. Personally I would not touch long dated bonds with a barge pole - I would rather by a house!

[Housing Bear]

But there is no whiff of inflation. They see a deflating economy. So they buy goverment bonds for safety.

Until we return to an inflationary environment. In a deflationary environment there is nowhere else for them to put there money and get a decent return. Its all too risky. They will stick with government bonds. They will continue to buy a government's bonds unless they decide that particular government is in imminent danger of default.

Long term bond holders are obviously forward looking, over the full length the length of the bond. As they see the UK economy crashing, bailouts not working, banks basically bankrupt, and lowering interest rates having no effect whatever, bond holders are obviously worried about the government's only last bullet - Quantitative Easing - which is VERY inflationary. Personally I would not touch long dated bonds with a barge pole - I would rather by a house!

[Mikhail Liebenstein]

But there is no whiff of inflation. They see a deflating economy. So they buy goverment bonds for safety.

Until we return to an inflationary environment. In a deflationary environment there is nowhere else for them to put there money and get a decent return. Its all too risky. They will stick with government bonds. They will continue to buy a government's bonds unless they decide that particular government is in imminent danger of default.

I can smell inflation. Even now, many prices are soaring (mostly imports), but the RPI doesn't say so.

[SNACR]

Inflation is definitely seeping in out there and it will take hold like a virulent tropical disease. I think it likely that usurious interest rates will be visited on mortgage holders whether from rate rise to offset inflation or forced by a flight from bonds.

[Mikhail Liebenstein]

Inflation is definitely seeping in out there and it will take hold like a virulent tropical disease. I think it likely that usurious interest rates will be visited on mortgage holders whether from rate rise to offset inflation or forced by a flight from bonds.

Indeed, the Government moves one way and gets boxed-in in another.

Once the catch 22 was inflation or deflation.

Personally I think we have both, ie bi-flation (falling assets, rise in essential imports) , very nasty.

So what next?

"Well lets cuts interest rates to stimulate spending. "

" Damn all the investment capital is leaving the UK, what can we do?"

"Ah, we'll have to raise interest rates."

Edited February 13, 2009 by mikelivingstone

[thod]

If they sell off bonds, then what will they do with the cash. You lose to inflation if you hold it. The only alternative is other asset classes. Yet the stock market is going down and so is property. So what will you put it into? The question is do you prefer to lose money to inflation or a declining market.

[Mikhail Liebenstein]

If they sell off bonds, then what will they do with the cash. You lose to inflation if you hold it. The only alternative is other asset classes. Yet the stock market is going down and so is property. So what will you put it into? The question is do you prefer to lose money to inflation or a declining market.

The funds will leave the UK, driving down Sterling, and creating bi-flation and making Government borrowing harder.

As to where the money will go? Anywhere where it can find a Yield - Australia?

[crash2006]

Bond traders are doing pretty well at the moment, i think mervin king et al havent thought out the serious side effects about QE and bonds. If they do go ahead and start QE then its pointless having your money in bonds infact your investment in bonds could be wiped out later on.

Infact PPP the us under obama getting private investors to buy bonds then later on wiping them out with QE, could see the bond market collapse.

infact if i were a private investor i would really start to think about selling my gov bonds.

Edited February 13, 2009 by crash2006

[Mikhail Liebenstein]

Bond traders are doing pretty well at the moment, i think mervin king et al havent thought out the serious side effects about QE and bonds. If they do go ahead and start QE then its pointless having your money in bonds infact your investment in bonds could be wiped out later on.

Infact PPP the us under obama getting private investors to buy bonds then later on wiping them out with QE, could see the bond market collapse.

Exactly, we already have our next bubble. Its a bond bubble.

QE will pr1ck it.

Edited February 13, 2009 by mikelivingstone

[Mina]

Send to: [email protected]?

(Heyyy. )

It's the Ponz!!

[crash2006]

Exactly, we already have our next bubble. Its a bond bubble.

QE will pr1ck it.

The funny thing the world govs need the bond market now more than ever, if QE goes ahead they are in trouble, infact serious trouble.

I do see what i call the Isosceles event =collapse.

Edited February 13, 2009 by crash2006

[Mikhail Liebenstein]

The funny thing the world govs need the bond market now more than ever, if QE goes ahead they are in trouble, infact serious trouble.

I do see what i call the Isosceles event =collapse.

Indeed. It was the foreign investment that helped keep us afloat whilst we ran huge deficits.

We now need to start making stuff, and to do that needs capital, so we need the bond markets (Govt and Corporate) more than ever.

[mdman]

This will be decided by politics IMO.

Foreign governments (China, UK, Japan, Germany, SWFs) finance US debt

All their domestic economies are collapsing

Riots and strikes are happening or about to happen

The choice they face is:

1. Stop buying UST, spend the money back home (welfare and works) to quell popular uprisings and possibly stay in power, with a high probability of precipitating GDII by crashing the US bond market

2. Keep buying UST diverting money from the domestic economy crashing it thus guaranteeing loss of power with not a great chance of preventing GDII anyway

3. Buy UST with printed money secretly (what the central banks may well have already started doing) - this might delay but will not prevent domestic economy crashes, so they lose power anyway

This becomes like prisoner's dilemma - and I am sure they will stop buying UST. Just as I am sure in the UK Brown will do a complete U-turn on protectionism within months (if not weeks) with the whole EU 'free movement of labour' ultimately go up in smoke

[Mikhail Liebenstein]

This will be decided by politics IMO.

Foreign governments (China, UK, Japan, Germany, SWFs) finance US debt

All their domestic economies are collapsing

Riots and strikes are happening or about to happen

The choice they face is:

1. Stop buying UST, spend the money back home (welfare and works) to quell popular uprisings and possibly stay in power, with a high probability of precipitating GDII by crashing the US bond market

2. Keep buying UST diverting money from the domestic economy crashing it thus guaranteeing loss of power with not a great chance of preventing GDII anyway

3. Buy UST with printed money secretly (what the central banks may well have already started doing) - this might delay but will not prevent domestic economy crashes, so they lose power anyway

This becomes like prisoner's dilemma - and I am sure they will stop buying UST. Just as I am sure in the UK Brown will do a complete U-turn on protectionism within months (if not weeks) with the whole EU 'free movement of labour' ultimately go up in smoke

Perfect.

We have a prisoner's dilemma (Tick)

and a catch 22 (Tick)

[Mikhail Liebenstein]

BTW, a bond market collapse is almost 100% guaranteed.

Out of all the City folk I've ever met, I have the most respect for (Government) bond traders - only because they actually understand the value of the assets they are trading. Right now, the value of said bonds it pretty much at a peak. Perhaps one last jump as yields fall down to 0.5%, but then there is now where left to go. What is the point of picking up a 0.5% yield, you might as well sit round collecting bits of toilet paper.

[Culpability Brown]

Perfect.

We have a prisoner's dilemma (Tick)

and a catch 22 (Tick)

This catch 22 situation has been in place for a number of years in my opinion it's only now come to the fore as more and more desperate reactive policies are put into action.

Systemic collapse has to be avoided until a consensus resolution is reached - noone knows what that will look like I just hope the G20 come up with something intelligent and civilised.

[A.steve]

BTW, a bond market collapse is almost 100% guaranteed.

I wish I had your certainty. I think it's all about foreign exchange rates. If we're willing to devalue Sterling substantially... we're going to be able to avoid a bond crisis (I think) but that would have significant repercussions for quality of life in Britain... where most consumer paraphernalia is imported... and would become unaffordable.

What I don't get is that in 1992, the ERM debacle resulted in raising £16bn using sovereign debt... which lead interest rates to rise to ~15%... Sure, that was because the exchange rate was defended... but how exactly are the triple 'exchange rate', 'interest rate' and 'extra state borrowing' related? We've seen a ~20% devaluing of sterling and interest rates drop to 1%... How can we anticipate the level of government borrowing that will cause a problem? Does anyone have any predictions - or is it 'wait and see' for everyone?