Mark June 19, 2013, down on your calendar. Because it will likely go down in history as the day the Federal Reserve’s four-year quantitative-easing program began its long, slow, painful death — and the day the sell-off in the $38 trillion U.S. bond market reached a massive tipping point.
A tipping point from massive bubble to painful bust.
Consider: The U.S. central bank’s $3.4 trillion bond-buying program drove yields — and all types of interest rates, from loans to mortgages — to record lows. That encouraged consumer spending, home buying and the biggest wave of risk taking ever seen in the financial markets.
But now, while Fed Chairman Ben Bernanke said the central bank still plans to buy $85 billion a month in bonds and keep rates close to zero for some time, the bond market stopped listening. Investors who were already selling bonds gradually for several weeks, flat out dumped them. And since then, they’ve kept on selling, unleashing one of the worst bond market sell-offs I have ever seen.
Here’s what happened yesterday and the day before:
- Ten-year Treasury yields exploded higher by as much as 15 basis points to 2.33%, then another 10 points to 2.43%. That’s the highest this benchmark interest rate — which is used to guide rates on everything from home mortgages to long-term corporate loans — has been since August 2011.
- Five-year yields surged by an even larger 18 basis points to 1.23%. That’s the highest level in 22 months. On a percentage basis, the surge was almost 17% in a single day, the biggest one-day move in more than 50 years of record-keeping.
- Bond prices, which move in the opposite direction of interest rates, are plunging. The iShares National AMT-Free Muni Bond ETF (MUB) took it on the chin, showing that even supposedly safe municipals are anything but. This ETF has now given up every penny of gains racked up over the previous 22 months.
- The Vanguard Total Bond Market Index (BND), one of the biggest bond market ETFs in the world with $115 billion in assets, collapsed. It hasn’t been this low since April 2011.
The bond-market bust was a long time coming, if you’ve read my columns this year and last. But some investors — even big-time mutual fund managers — got caught flat-footed. Why? Just like real estate in the 2000s and tech stocks in the late 1990s, those bull markets were artificially extended for years, and those who got out early lost out on some of the biggest gains.
|The bond-market bust was a long time coming. Even big-time mutual fund managers got caught flat-footed.|
Pimco bond-fund manager Bill Gross sold his U.S. government debt in February 2011 and even shorted the securities, missing out on additional gains as yields dropped to almost 1.5 percent. His rival, Jeffrey Gundlach of DoubleLine Capital, said hours before the Fed’s announcement June 19 that Treasuries are still the place to be.
But make no mistake. The real problem is what I’ve been harping on for several months: The bond market is a gigantic bubble, having been wildly inflated by too much cheap, easy money from the world’s central banks.
We’ve seen massive printing in the U.S. We’ve seen massive printing in the U.K. We’ve seen massive printing in Japan and elsewhere. And that has inflated bonds far beyond their intrinsic value.
Things have gotten so out of control, in fact, that one of the Bank of England’s own policymakers, Andy Haldane, just told a British government audience:
“Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history. … We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.”
His words came just days after the declaration by Dallas Fed President Richard Fisher that the 30-year rally in bonds is dead.
If you’ve been following my advice, you’ve dodged the wipeout in bonds. You dumped your long-term Treasuries, municipal bonds, and especially your junk bonds and emerging-market debt long ago, just as I recommended.
If you haven’t done so yet, for whatever reason, I urge you to heed this warning. The bond market just suffered its worst month in a couple of years in May, and the Fed’s Bernanke essentially issued a “strong sell” recommendation on June 19.
I believe recent declines are a prelude of what’s to come over the next several months. Wait for a short-term bounce if you want to get better prices. But don’t lose sight of the long-term goal: to reduce your exposure to a wildly inflated asset class that stands to lose a lot of value if the past two bubble busts — in tech and housing — are any guide.
Until next time,