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R K

How Scary Is The Bond Market? Robert Shiller (Int Rates/house Prices)

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http://www.project-syndicate.org/commentary/bond-market-crash-contagion-by-robert-j--shiller-2015-03

Short article - worth noting

All of these yields have since moved slightly higher, but they remain exceptionally low. It seems puzzling – and unsustainable – that people would tie up their money for 20 or 30 years to earn little or nothing more than these central banks' 2% target rate for annual inflation. So, with the bond market appearing ripe for a dramatic correction, many are wondering whether a crash could drag down markets for other long-term assets, such as housing and equities.

It is a question that I am repeatedly asked at seminars and conferences. After all, participants in the housing and equity markets set prices with a view to prices in the bond market, so contagion from one long-term market to another seems like a real possibility.

We now have more than 40 years of additional data, so I took a look to see if our theory still predicts well. It turns out that our estimates then, if applied to subsequent data, predicted long-term rates extremely well for the 20 years after we published; but then, in the mid-1990s, our theory started to overpredict. According to our model, long-term rates in the US should be even lower than they are now, because both inflation and short-term real interest rates are practically zero or negative. Even taking into account the impact of quantitative easing since 2008, long-term rates are higher than expected.

But the explanation that we developed so long ago still fits well enough to encourage the belief that we will not see a crash in the bond market unless central banks tighten monetary policy very sharply (by hiking short-term interest rates) or there is a major spike in inflation.

Bond-market crashes have actually been relatively rare and mild. In the US, the biggest one-year drop in the Global Financial Data extension of Moody's monthly total return index for 30-year corporate bonds (going back to 1857) was 12.5% in the 12 months ending in February 1980. Compare that to the stock market: According to the GFD monthly S&P 500 total return index, an annual loss of 67.8% occurred in the year ending in May 1932, during the Great Depression, and one-year losses have exceeded 12.5% in 23 separate episodes since 1900.

It is also worth noting what kind of event is needed to produce a 12.5% crash in the long-term bond market. The one-year drop in February 1980 came immediately after Paul Volcker took the helm of the Federal Reserve in 1979. A 1979 Gallup Poll had shown that 62% of Americans regarded inflation as the “most important problem facing the nation." Volcker took radical steps to deal with it, hiking short-term interest rates so high that he created a major recession. He also created enemies (and even faced death threats). People wondered whether he would get away with it politically, or be impeached.

Regarding the stock market and the housing market, there may well be a major downward correction someday. But it probably will have little to do with a bond-market crash. That was the case with the biggest US stock-market corrections of the last century (after 1907, 1929, 1973, 2000, and 2007) and the biggest US housing-market corrections of all time (after 1979, 1989, and 2006).

It is true that extraordinarily low long-term bond yields put us outside the range of historical experience. But so would a scenario in which a sudden bond-market crash drags down prices of stocks and housing. When an event has never occurred, it cannot be predicted with any semblance of confidence.


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Not read link but Bonds were scary in 2014 and grew 30%!!!!!!!

Scary in 2015 yet flat so far.

Economists love to be bearish or bullish but often don;t look at what the market is actually doing.

Fact is govt bond yields have been falling globally. For someone to come out and say they'll soar (bonds crash) is par for the course. BTW 67/67 economists/commentators said they would crash in 2014 (as at Dec 2013)... (Barrons.)

Edited by Killer Bunny

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broadly in agreement with Hoisington's view - which will be updated for Q115 early April

http://www.hoisingtonmgt.com/hoisington_economic_overview.html

They make v g points. Re falling yields its as much to do with economics as what everyone else is doing. All around World yields are falling, in EU over 25% 10yrs now NEGATIVE!!!

Yet we should be scared of Bond prices. Got it, thx Prof Shiller.

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They make v g points. Re falling yields its as much to do with economics as what everyone else is doing. All around World yields are falling, in EU over 25% 10yrs now NEGATIVE!!!

Yet we should be scared of Bond prices. Got it, thx Prof Shiller.

If you bothered to read what I posted you would see he says the opposite.

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Worldwide QE must have a fair impact on the 'demand' for these bonds (ie. pushing their values higher and yields lower) ?

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QE in US drove yields UP. Ending QE 1, 2 and 3 drove them down... The pundits want people to believe QE is about buying Govt Bonds. Facts are facts.

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It's interesting that he cites Volcker's role in the biggest bond market crash in US history. Volcker was reacting to the stagflationary dynamic unleashed by the Nixon shock a decade earlier, itself a consequence of the exponential growth of eurodollar markets from the late fifties onwards. By 1961 the order of magnitude of dollars, or dollar equivalents, outside the USA and the jurisdiction of the Fed was far greater than the US gold supply in dollars. In practical terms, by the time the US defaulted from Bretton Woods in 1971 M3/M2 was much too large for the central banks to control in a co-ordinated fashion.

This state of affairs essentially repeated itself in 2008. I believe the central bank response to the GFC will follow the same pattern as the 70s, eventually manifesting itself as stagflation (as is now the case in Japan), and if that fails hyperinflation. A gigantic bond market crash is thus inevitable.

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It's interesting that he cites Volcker's role in the biggest bond market crash in US history. Volcker was reacting to the stagflationary dynamic unleashed by the Nixon shock a decade earlier, itself a consequence of the exponential growth of eurodollar markets from the late fifties onwards. By 1961 the order of magnitude of dollars, or dollar equivalents, outside the USA and the jurisdiction of the Fed was far greater than the US gold supply in dollars. In practical terms, by the time the US defaulted from Bretton Woods in 1971 M3/M2 was much too large for the central banks to control in a co-ordinated fashion.

This state of affairs essentially repeated itself in 2008. I believe the central bank response to the GFC will follow the same pattern as the 70s, eventually manifesting itself as stagflation (as is now the case in Japan), and if that fails hyperinflation. A gigantic bond market crash is thus inevitable.

If you havent yet watched Varoufakis explanation of the failure of the US dollar surplus recycling mechanism (Bretton Woods) in the late 60s and Volckers recognition that to retain their benevolent hegemony US would need to switch to running deficits in order to recycle the rest of world surpluses which is what ended with the similar but in effect reverse failure in 2008, I recommend you do so.

Varoufakis "global minotaur" but similar to Kindlebergers "benevolent hegemon".

Position at present is current system has not yet been replaced with whatever will become the next mechanism for resolving global imbalances. In essence for globalism to continue we will need either a global agreement (BW II if you like) or one of Euro/US/China to take on the role (obvious problems with both EZ - i.e. germany dont get it and China)

We are in the rather unsettling inter-regnum period which will continue until that future emerges.

Unfortunately political classes seem rather more focussed on trivia.

Edited by R K

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I believe the central bank response to the GFC will follow the same pattern as the 70s, eventually manifesting itself as stagflation (as is now the case in Japan), and if that fails hyperinflation. A gigantic bond market crash is thus inevitable.

That's what they said of Japan for 15 years. Even the last 2-3 yrs of mild inflation they've been screaming it. JGBs? No movement...

Edited by Killer Bunny

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When an event has never occurred, it cannot be predicted with any semblance of confidence.

Reminds of the comment I read somewhere that the people on wall street proclaiming a new paradigm were supporting their claim with historical research that-if their claim were correct- would be totally invalid as a source of data for the obvious reason that it was drawn from a time when that new paradigm had not been in place and therefore could have little to say about the radically altered situation in which we allegedly found ourselves.

This is almost a literal translation of the idea that one could in reality navigate an unfamiliar terrain by focusing entirely on the image in the rear view mirror.

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If you havent yet watched Varoufakis explanation of the failure of the US dollar surplus recycling mechanism (Bretton Woods) in the late 60s and Volckers recognition that to retain their benevolent hegemony US would need to switch to running deficits in order to recycle the rest of world surpluses which is what ended with the similar but in effect reverse failure in 2008, I recommend you do so.

Varoufakis "global minotaur" but similar to Kindlebergers "benevolent hegemon".

Position at present is current system has not yet been replaced with whatever will become the next mechanism for resolving global imbalances. In essence for globalism to continue we will need either a global agreement (BW II if you like) or one of Euro/US/China to take on the role (obvious problems with both EZ - i.e. germany dont get it and China)

We are in the rather unsettling inter-regnum period which will continue until that future emerges.

Unfortunately political classes seem rather more focussed on trivia.

I haven't read him but thanks for that, I'll deffo have a look. One (hugely) complicating factor that wasn't an issue 50 yrs ago is the role played by derivatives but even when we restrict ourselves to looking at M3 the unsustainability of dollar liquidity outside the US in the aftermath of 2008 is striking.

chart-hysteria-1.jpg

M3 >> M2 in 2008.

Incredibly, after a minor post-Lehmans reversion, that still appears to be true in 2015.

money_supplyM1M2M3actual.png

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Reminds of the comment I read somewhere that the people on wall street proclaiming a new paradigm were supporting their claim with historical research that-if their claim were correct- would be totally invalid as a source of data for the obvious reason that it was drawn from a time when that new paradigm had not been in place and therefore could have little to say about the radically altered situation in which we allegedly found ourselves.

This is almost a literal translation of the idea that one could in reality navigate an unfamiliar terrain by focusing entirely on the image in the rear view mirror.

Which is why he seems to be saying that since it has never happened "it cannot be predicted with any level of confidence"

i.e. it would be a black swan

he adds the riders

we will not see a crash in the bond market unless central banks tighten monetary policy very sharply (by hiking short-term interest rates) or there is a major spike in inflation.

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I don't remember who the quote is attributed to, but it goes something along the lines of 'these events that should statistically happen once every 100 years happen every 5 years or so in financial markets'

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