Thursday, February 9, 2012
As this chart suggests, long-term bond yields have a strong tendency to track the strength of the economy (as reflected in equity prices). Except for the past four months, that is, as equity prices have surged 23% but long bond yields have barely budged. You can almost feel the tension in the bond market building. Something is going to have to give—either equity prices and budding economic optimism have to collapse, or bond yields have to surge. It just doesn't make sense for the economy to be doing better while bond yields languish near all-time lows. My money is on higher yields, since the evidence of continued economic improvement is pervasive.
The Fed may hold a significant amount of long-term Treasury bonds, but they can't control long bond prices, and there are gobs of them that are held by investors all over the world. Those investors face the prospect of massive losses should bond yields once again sync up with equity prices. With the duration of the current 30-yr bond now 19, the price of the long bond could fall by 25% or so if 30-yr yields return to the levels of early last year. And that would still leave 30-yr yields very close to the low end of their range over the past three decades. Bond buyers beware.
Posted by Scott Grannis at 9:47 AM