Why are bond prices falling?

May 18, 2015

- By Bill Bonner

Bill Bonner
Buenos Aires, Argentina

Dear Diary,

We stumbled, shuffled and dragged both feet as we made our way down from our mountain ranch. Now, we're sitting in the airport, waiting for a flight to Colombia.

After 3 months in the thin air of the high sierra, we're not quite prepared for the soup down below. It is warmer. It is easier to breathe. But there are things down here - swimming in the broth of public information, news and opinion - that we can't quite identify. And they're making us a little queasy.

In the financial markets, for example, we have been waiting for a crash of equity prices. And waiting. And waiting. It still hasn't come.

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And last week continued the spectacular bull market that began in March '09 with even more gains. On Friday, the momentum seemed to flag with a 20 point gain in the Dow, but it was still a robust week for US stock prices.

But the real action was in the bond market. Bloomberg has the report:

Global bonds have lost $456.4 billion of value in about three weeks. It sounds exciting, but you'd never know it from looking at trading activity.

Buying and selling on ICAP's BrokerTec platform was below the annual average in the past month, and Treasury volumes at Wall Street's biggest bond dealers just had their worst April in six years. Corporate-bond trading at those brokerage firms also slumped 14 percent in April compared with the same month in 2014.

This is the latest evidence that it doesn't take a whole lot to cause a rout in bonds these days. Record central-bank stimulus has sent investors piling into debt at the same time that dealers pulled back from making markets -- a combination that means a relatively small amount of trading in $41 trillion of notes can result in a monthly loss that's bigger than Venezuela's economy.

"The dramatic sell-off in government bond markets last week should be a stark reminder of just how congested a lot of market positioning has become," Citigroup Inc. strategist Mark Schofield wrote in a report this week. As trades become more crowded, "it becomes increasingly difficult for investors to exit those positions when the time comes to do so."

That means that it will be increasingly difficult for central banks to start backing away from their unprecedented stimulus efforts as growth takes hold -- no matter how much they may want to -- without causing a massive traffic jam of investors all trying to sell at once.


We don't know whether this crash in bond prices will continue or not. It is almost too classic to believe. Serious economists - and anyone with any common sense - have realized for centuries that you can't increase the quantity of debt without also decreasing its quality. The more you owe, the less likely you are to pay.

And yet, central banks have been encouraging debt all over the planet. They claim this will 'stimulate' the economy and the resulting 'growth' will make it easy to repay the debt. In fact, Mario Draghi, the John Law of modern central banking, told us that the European Central Bank would persist in its delusions. Again, Bloomberg reports:

    Mario Draghi said the European Central Bank's non-standard measures have proven effective, and low interest rates haven't yet led to financial imbalances.

    Unconventional actions "have proven so far to be potent, more so than many observers anticipated," the ECB president said in a speech in Washington. "While a period of low interest rates will inevitably result in some local misallocation of resources, it does not follow that it has to threaten overall financial stability" and "there is little indication that generalized financial imbalances are emerging," he said.

    Draghi reiterated that the ECB is committed to implementing its 1.1 trillion-euro ($1.2 trillion) asset-purchase plan "in full," and "in any case" until inflation has recovered lastingly.

Why would bonds sell off at the very moment when the biggest - and practically, the only - buyers in the world are promising to load up with more? Ah...that is what is so classic. While the ECB pledges to throw good money after bad, private institutions - banks, hedge funds, pension funds - are beginning to see low-yield debt as a leaky boat. They've made a lot of money buying in anticipation of QE programs; they don't want to lose their gains when the bond market sinks...as it inevitably will.

The claims made on behalf of money printing have never had any sensible basis in theory...and have once again proved ineffective in practice. The US Fed has printed far more money than ever before in history and yet this 'recovery' is the weakest on record. In fact, it is so weak that it is a stretch to call it a recovery at all. The only things that have recovered are asset prices - and those do not represent any genuine improvement in the real economy. What's more, they can correct to the downside at a moment's notice. And will!

Asset prices pushed up by money printing are fundamentally phony. Because there is no real wealth creation behind them. The higher they go, the more they become detached from the real economy...and the more vulnerable they become. That is true for stocks as for bonds. In the case of bonds, it is...as we said...classic. You can't improve your credit standing by borrowing more money. So, it is inherently absurd for sovereign debt to go up in price as the borrowers go further and further underwater...dragging investors with them.

Sooner or later they'll all have to come up for air.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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