Long bull market in bonds is unwinding

“They don’t ring a bell at the top” is a phrase usually heard rolling off the tongue of some broker trying to sell one thing or another. But the saying is partially true. While they don’t ring an actual bell at the top, the market does provide some pretty clear warning signals.
Most financial market participants recognize that the majority of the last five years’ worth of stock market gains has come on the back on the Federal Reserve’s easy-money crusade. Negative real interest rates, coupled with massive bond buying on the part of the Fed, have been the thermals under the wings of markets.
Corporations large enough to issue long-term bonds have continually refinanced interest debt at lower and lower levels, decreasing overall debt burdens and bumping up earnings. Even companies that don’t need the money have taken advantage of lower interest rates to borrow from the bond market and then use the money to buy their own stock – often with a dividend greater than what’s paid to borrow the funds. Low interest rates have allowed for the creation of billions of dollars in market value for U.S. companies.
While the central bank has been successful for at least two decades at pushing back the day when financial markets will seek some sort of equilibrium, meaning honest, risk-based pricing, there is some evidence that that day may have arrived.
Over the last six months, the rate on the 10-year U.S. Treasury has increased from 1.6 percent to 2.8 percent. Make no mistake: the central bank authorities and Washington do not want higher rates, especially not an increase of almost 50 percent in a period of six months. That’s magnitude plus velocity. Substitute magnitude with mass and you can use physics to calculate the force or impact of rising interest rates. Rates rising that far, that fast, will have an enormous impact on everything they touch.
Has the Fed lost control? Is this happening despite their best efforts or are they allowing it to occur? The Fed has no reason to want rates to increase. The economy is still weak. Our trading partners are, or soon will be, in recession. And employment remains less than optimal. No, rates are going up because there are more sellers than buyers.
During the last two months, foreign holders of U.S. Treasury debt, individuals and sovereigns sold more paper than at any time in recorded history. Large hedge funds, those using billions in leverage, have been unloading the same assets. And now the smaller funds and investment managers have started selling. It’s quickly becoming a race to the exit.
The market is overruling the Fed. If the climb towards 3 percent continues on unabated, consider the bell to have been rung. If you have not done so already, it’s time to begin selling longer-dated bonds of all types with an emphasis on the poorest credits. A 30-plus year bull market in bonds is starting to unwind, and it’s likely to get ugly. •


David Brochu is president and CEO of Kleossum advisors.

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