Bond market train wreck

US markets are still very sensitive to hints of slowdowns, rate hikes, and inflation. And in the wake of the Fed’s rate cuts last month, yields have gone up, not down.

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Friday, October 25th, 2024

Bill Bonner, writing today from Baltimore, Maryland 

I'm turning Japanese 
I think I'm turning Japanese 
I really think so 

—The Vapors 

Why would 250 young people go into a large auditorium, strip naked, and ‘do it’ all together? 

Because they are Japanese? 

So far, we’ve confined our ‘what have we missed’ search to the bushes and by-ways along the path we think most likely.  

But what if we go in a different direction altogether? What if the road takes us to Japan? 

Suppose the end of the Primary Trend did not come in 2020-2022. What if that was just another data point... another interim peak in the great bond bull market that began in 1980? If so, can’t we expect lower interest rates in the future... not higher ones? And lower inflation too? And more debt... much more debt? 

This hypothesis has the advantage of being very contrarian and hard to follow. The idea is that worldwide, big investment pools — such as insurance companies, pension firms, and governments themselves — use US Treasury bonds as a ‘safe haven,’ long-term asset.  

Yes, they took a beating on those bonds in ‘20-’22... but now they believe the inflation crisis is over. They think it was caused by a one-time event, the Covid crisis. That won’t be repeated anytime soon, or so they believe. 

And now, the world has more than $300 trillion in debt... and more than $400 trillion in assets. But there are only $14 trillion in 2,3,5,7 or 10-year US Treasuries outstanding. Any kind of non-inflationary crisis – a bear market in stocks, for example - should lead to spirited buying of these Treasury notes, driving prices up... and yields down.  

We even have an example... a pattern that might be repeated: Japan. 

Japan’s stock market crashed in 1990. It went into a bear market that lasted 22 years. People were happy to take ultra-low yields from bonds to protect themselves. This allowed the government to spend, borrow and print on a scale almost unimaginable... its gross debt is now at 260% of GDP, more than twice that of the US.  

Back in 2009, Japan already had a debt-GDP ratio of 200%. It was then that the Financial Times reported on what looked like an imminent train wreck: 

Japan is moving into an orgy of public spending, as the government announced plans on Tuesday to issue extra bonds worth ¥10,820bn ($110bn) to fund its planned ¥15,400bn ($155bn) stimulus package, announced earlier this month. The questions are, will it work and is the bond issuance sustainable? As Reuters notes, the extra bonds, while expected, will raise new issuance by a third this fiscal year to a record ¥44,000bn ($448bn), raising concerns among investors about how the market will cope with the additional supply and helping push up bond yield spreads. In fact, total new issuance may eventually reach ¥16,900 ($172bn) worth of bonds, according to a government draft plan obtained by Reuters. That is a lot for an economy that is already running a debt to GDP ratio skirting 200 percent (even though it does boast one of the biggest pools of savings in the world).  

But the train wreck never happened.  

We don’t pretend to know why. Maybe Japan is special.  It gave us hara-kiri, kamikazes and sushi. At least two WWII Japanese soldiers held out in the jungles for thirty years after the war was over. And its people don’t even have children. JapanTimes: 

Japan's population shrank for the fifteenth year in a row as the country continues to grapple with a chronically low birth rate, an annual report released Wednesday by the ministry of internal affairs shows. The number of Japanese residents fell by 861,000 (0.7%) from a year before — marking its steepest decline ever — to 121,561,801. 

Many Japan experts say its economy is just as strange. That is, it doesn’t function like other developed economies. But Japan is not in a crisis. People still eat raw fish. They still make good cars. Crime is very low. And the stock market... after 34 years... is now back to where it was in 1990 (just about). 

Could the US follow the pattern?

Probably not. 

In the absence of tomorrow’s news... we note that in today’s news comes word that US markets are still very sensitive to hints of slowdowns, rate hikes, and inflation. And in the wake of the Fed’s rate cuts last month, yields have gone up, not down. MarketWatch: 

Government debt sold off for a third straight session Wednesday, pushing long-dated Treasury yields further into three-month highs, as investors remained wary that the approaching Nov. 5 election could exacerbate the government’s fiscal deficit... 

What this tells us is that sophisticated bond pros are not going to sit idly by while policymakers add more debt. From July 2020 until October 2023, the yield on a 10-year Treasury bond rose by a factor of ten, while the real value of 10-year US treasuries went down nearly 15% in the first quarter of 2021 alone. 

Investors are not likely to forget that Big Loss... and won’t be eager to repeat it. 

Regards, 

Bill Bonner