Bond vigilantes routed as bubble forming
The bond vigilantes are running for the hills. Traders that have tried to short bonds in recent months have gotten their faces ripped off (as they say in the trading pits), and they can’t seem to get the bond market pointed in the other direction.
With the 10-year yield (^TNX) dragging along at 6-month lows even as the Fed tapers, the strength in the bond market seems confounding. Scott Nations of NationsShares thinks we’re seeing a bubble forming right in front of our eyes, and it’s because of the Fed.
“There’s just no rationale” for bonds to yield 2.6%, Nations says in the attached video. “If 2nd quarter growth is above 3%, then there’s no reason for bonds yields to be where they are, except for the fact that the Fed is the biggest buyer of bonds in the world and they’re going to continue to be the biggest buyer of bonds for some time."
The Fed has been buying billions of dollars worth of bonds and mortgage-backed securities for quite some time. Tapering of these purchases began late last year, and will likely continue to follow through until the end of the program in late 2014. With the Fed exit pretty much well telegraphed, bond traders are scratching their heads as to why yields haven’t moved higher with Fed buying tapering off.
My colleague Mike Santoli has a few reasons why, including the below:
Investors are coming around to Fed Chair Janet Yellen’s message that, after the Fed sunsets its QE program – perhaps by October, possibly later – it will still be a relatively long time before short-term interest rates are lifted. The important point of Yellen’s recent line of communication is that short-term interest rates will ultimately peak at far lower levels than in past “normal” economic cycles.
See Related: A year since 'taper tantrum,' bond market calm confounds investors
With the expectation of rates staying low for quite a long time (including rates around the world), according to Nations bond traders are “gritting their teeth” and buying bonds, because they can’t think of any other place to put their money. And for Nations, that’s not a good enough reason to think bond yields will stay where they are.
Even if we know what the Fed’s doing, Nations thinks once the taper is finished we’ll have a normalized bond market. With the Fed’s buying out the way, yields will eventually rise. There will be an opportunity to get short bonds before then, just not right away.
If investors are interested in shorting the bond market, Nations suggests the ProShares UltraShort 20+ Year Treasury (TBT) as one way to get behind the trade.
