Bonds Predict the New Normal

The bond market is predicting PIMCO's New Normal environment: slow growth, little inflation. The bond funds are signaling no confidence in the direction of US fiscal policy.

Inflation is not the issue. The inflation-adjusted TIPS are showing very low real yields, close to real LIBOR. 

A strong recovery is not the issue. This chart from Bloomberg as analyzed by Calafia Beach Pundit shows the current yield curve in red, and Boomberg's forward projections in purple (one year out), yellow (two years) and green (five years). The projection shows the Fed raising the Fed Funds rate to 1% in one year and 2.25% in two years on its way to 4.5%. These future curves show little to get excited about; real growth would drive the long end more steeply. 

The US deficits are the issue. The risk for bond investors is a rise in the longer rates due to the need to finance the huge deficits. After a flurry of poor auctions following the ObamaCare bill passing, the Treasury markets have settled down, at least for the moment. Yet this may be a calm before the storm. 

When gold rises, it is usually looked at as an inflation indicator, but that is too simplistic; it is really a hedge against bad government. The bond market also can indicate a lack of confidence in government - just watch Greek bonds right now. The major bond funds in the US are voting against Obama by becoming seriously underweight in Treasuries: 

• PIMCO has dropped in to 27.5% and shortened durations
• Templeton owns no Treasuries in its Global Return Fund
• Wellington has only 13.5% whereas a typical bond fund would be well over 50% 

Comments

[robert]

Not to diminish the magnitude of the sovereign debt problem but I still get the feeling Treasuries are shunned more out of fear of imminent inflation than US default. Considering what I read about how the US military still calls the shots globally I can imagine a whole pile of other debt out there, miles ahead of the US in the default queue, turning turtle long before US Treasuries. Of course the real test will come when global equities descend from high orbit. Until then, unlike Bloomberg, I will reserve the right to be wrong.

[Eventhorizon]

There is no possiblity of actual default of US sovereign debt. Effective default via monetization is another story.

PIIGS and CA / IL / FL do not have that luxury.

[Mamma Boom Boom]

Will Obama make it thru 4 years or will the births finally take him out?

[yelnick]

Mamma, if by "births taking him out" you mean a court removing him due to proof he is not a Natural Born Citizen, no. Forget about this. 

I think the rupture to the political fabric would be huge if this argument were successful. Even if a case could be made, I cannot imagine a US court taking on a President like that. The proper way would be to file a quo warranto motion in the DC Circuit, but I cannot imagine the US Atty taking that on to initiate the process.  It would take a political calamity that weakens Obama like Watergate did Nixon for anything like this to be more than fringe.

The tactic that is slowly being figured out is to challenge his eligibility for the 2012 election. I do not know if this will be successful. The easier argument than place of birth is the interpretation that NBC is not the same as native born - it means a second generation citizen, born in America of American parents. Obama admits his father was not an American, which means under this interpretation of NBC that he is not an NBC. Apparently in a 2004 debate with Alan Keyes he admitted that he was not eligible for President, but pointed out that he was running for Senate at the time, which had no NBC requirement. But for this to work that standard would have to be unambiguous. In four prior Supreme Court decisions, they repeated that mantra ("born in America of American parents") or its equivalent, but the cases are over 100 years old and did not directly read on a Presidential eligibility (although one came close, back in the early 1900s). 

[Chabazite]

Generally good Q1 results so far, but some slightly raised eyebrows ... IBM, Boeing, Microsoft, Amazon. I thought the following snippet was of interest. 'Investors were looking for a bigger revenue gain than the average 7.4 percent that companies have posted so far, particularly given easy comparisons with the year-ago period when the U.S. was in the depths of recession, said Peter Sorrentino, who helps manage $13.3 billion as a senior portfolio manager at Huntington Asset Advisors. The market may stall until profit is driven more by rising sales than cost cuts, he said. 'Ultimately you have to have a revenue growth story. Let’s see results, let’s see end demand.' http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aQCHm8R3M13g If Q2 and Q3 are the same, the markets will start to fall in anticipation. My guess is that, ceteris paribus, there is not much more upside but we may have a few months of bumping against a ceiling before a steady decline.

[colion]

If bond funds and foreign governments are cutting back on their treasury buy would it be unreasonable to assume that higher rates are around the corner? If so, TIPS might pop sooner rather than later but might not do so until rates start moving.

[Mamma Boom Boom]

Yelnick, thanks for your input.