Pages

Monday, January 12, 2015

The Yellen Bond Bubble


  • Bond yields are dangerously low.
  • Prices are falling and inflation expectations have become unanchored.
  • The Fed will have to act, and bond prices will have to fall.
  • Stocks are more remunerative than bonds right now.

Bond prices have soared and bond yields have declined by one-third since Janet Yellen became Fed chairman. Over the past six months, five-year expected inflation has declined from 2% (the Fed’s target) to 1.2%, a decline of 40%, and far below the Fed’s target. The Fed’s inflation target has lost credibility in the bond market.

In 1933, Irving Fisher wrote about deflation risk: “The more the economic boat tips, the more it tends to tip.” On the same topic, Ben Bernanke said that “the best way to get out of trouble is not to get into it in the first place”. In other words, deflation is much easier to prevent than to correct, as the ECB is learning at this very moment.

One of the Fed’s stated goals is to anchor expected inflation so as to avoid inflationary or deflationary pressures from building. Something happened in 2014 which caused inflation expectations to become unanchored, perhaps the premature taper of QE or the constant talk of a rate hike. It doesn’t really matter what caused expectations to become unanchored, because inflation expectations are the Fed’s job to manage, not an exogenous variable to be lamented. Deflation is a currency-specific monetary problem, and there is no such thing as “global deflationary pressure”. The Fed’s failure to anchor inflation expectations has created a big bond bubble that will need to be popped.

It is difficult to argue that the bubble won’t ever be popped because there is a “new normal” of low everything. The only way that we can have such a new normal is if the Fed were to permanently abandon its inflation target. Assuming it doesn’t do that, assuming that at some point it moves to raise inflation and expectations, the bubble will burst. We can’t live forever with five-year Treasuries yielding 50 bips less than the Fed’s inflation target.

I have just argued that the Fed will have to act in order to raise both expected inflation and bond yields. But please note that the bond market strongly disagrees with me: it has made it clear that it does not expect the Fed to do anything. If it agreed with me, we wouldn’t be seeing these frightening numbers.

Nonetheless, it is quite likely that, at some point this year, the FOMC will wake up and notice that things are slipping out of control, and will be forced to  take decisive action to raise expected inflation. For example, it could eliminate interest on excess reserves and launch an open-ended QE. If such a policy proved successful, bond prices would fall substantially (and deflation risk would be banished).

The do-nothing option is not really viable, because we are already seeing signs of deflation. Commodity and producer prices are falling, as is headline inflation (both CPI and PCE). How much of this is the transitory effect of falling oil prices and how much is a deeper phenomenon is not yet clear. But the fact that hourly wage rates are falling suggests that this problem may go deeper than the oil situation. The price of oil has declined many times before without causing general deflation (aside from the Crash which was about a lot more than oil prices).

Investment Conclusion

When bond yields are below the Fed’s inflation target, I think bond prices have entered risky terrain. The current low yields make stocks a better investment alternative (with expected total return around 7-8%), but stock prices are also vulnerable to higher bond yields, because higher yields compress the equity premium. Nonetheless, I feel safer being overweight equities and underweight longer-dated bonds. Stocks are an investment which will over time reward you with cashflow irrespective of subsequent price movements. Don’t buy for appreciation, buy for total return. Note that the market’s current dividend yield is higher than the 5-year bond yield, and about the same as the 10-year.

11 comments:

Anonymous said...

Hi,
Why are you saying that deflation is a currency specific phenomenon? Can we not have global deflation?

Robert said...

Janet have a same problem like Greenspan. Problem with communication...

Barry James said...


Hi everybody, I am Barry James ,currently living in canada. I am married at the moment with two kids and i was struck in a financial situation and i needed to refinance and pay for my son medical bill. I tried seeking loans from various loan firms both private and corporate but never with success,and most banks declined my credit. But as God would have it, i was introduced to a private loan lender by a friend and i got a loan sum of 30,000USD and today am a business owner and my kids are doing well at the moment. So dear,if you must contact any firm with reference to securing a loan with low interest rate of 2% and better repayment plans and schedule,please contact Elvin Morrison he doesn’t know that am doing this but am so happy now and i decided to let people know more about him, he offers all kinds of loans to both individuals and company and also i want God to bless him more. You can contact his company through this email elvinloancompany@yahoo.com

Kelvin Rachel said...

Hello everyone am here to testify how i got my loan from Mr Akisu. after i applied several times from various loan lenders who claimed to also testify right in this forum,i thought the testimonies where real and i applied but they never gave me loan. I was in need of an urgent loan to start a business and i applied from various loan lenders who promised to help but they never gave me the loan.Until a friend of mine introduce me to Mr Akisu. who promised to help me and indeed he did as he promised without any form of delay.I never thought there are still reliable loan lenders until i met Mr.Akisu,who are indeed helped with the loan and changed my belief.I don't know if you are in any way in need of a genuine and urgent loan,free feel to contact Mr.Akisu via his email{Akisuloancompany@gmail.com} Thank you may God bless you

anita zunon said...

Hello Everybody,
My name is Mrs Anita. I live in UK London and i am a happy woman today? and i told my self that any lender that rescue my family from our poor situation, i will refer any person that is looking for loan to him, he gave me happiness to me and my family, i was in need of a loan of $250,000.00 to start my life all over as i am a single mother with 3 kids I met this honest and GOD fearing man loan lender that help me with a loan of $250,000.00 U.S. Dollar, he is a GOD fearing man, if you are in need of loan and you will pay back the loan please contact him tell him that is Mrs Anita, that refer you to him. contact Mr.Robert,via email:(robertfinancial_loancompany@yahoo.com)Thank you

Hwa Jurong said...

Good Day !!

I am Hwa Jurong, a Reputable, Legitimate & an accredited money
Lender. I want to use this medium to inform you that i render reliable beneficiary
assistance as I'll be glad to offer you a loan at 2% interest rate to
reliable individuals.

Services Rendered include:

*Home Improvement
*Inventor Loans
*Car Loans
*Debt Consolidation Loan
*Line of Credit
*Second Loan
*Business Loans
*Personal Loans
*International Loans.

Please write back if interested.
Upon Response, you'll be mailed a Loan application form to fill. (No social
security and no credit check, 100% Guaranteed!) I Look forward permitting me to
be of service to you. You can contact me via e-mail:hwajurong382@yahoo.com hwajurong12@gmail.com
Yours Sincerely,

Hwa Jurong(MD).

Micheal Benson said...

To properly introduce myself, I'm Mr. Micheal Benson a private lender,i Give out loans at 3% interest rate, this a financial opportunity. at your door step, get your loan quickly. There's so much people out There looking for financial opportunities or help around the corner, and Places, and still they are not able to get one, but here it is. Financing opportunities on your door step and as such you can not afford To miss this opportunity This service is made to Individuals, companies, businessmen and women, and loans.The availability of any amount of your choice for more information. Contact us via email: michealbensonloanagency@gmail.com.

Loan application form and return it.

Full Name ................

Private phone number .............

Country .................

Address ...........

State ............

Age ..............

You have applied before or not. ...........
Status ............

Loan amount needed. ..............

Loan period ..............

Occupation...........

Monthly Income ..............

In recognition of these details we will send you our agreement with the repayment schedule, and if you agree to the Terms and Conditions, you stand to get your loan within 24 hours, depending on the severity and urgency,and trust.
I am waiting for your quick response.

Yours truly

Micheal Benson

Robert Malanowski said...

Yeah, and we have bubble on CHF, Brent, WTI, Gold and Copper...

Mat said...

Yellen have power like a president of USA IMO.

Packers And Movers Hitech City Hyderabad said...

nice really like your blog, thanks for share...
please visit are website..
Packers And Movers Hyderabad


Packers And Movers Lingampally Hyderabad

meto mayo said...



الفك والتركيب والتغليف والتحرك من خلال شركة نقل اثاث بجدة متميزة تحتاج الي ركن البيت للاستفادة من خدماتها التي لا تقدم غير خدمات نقل اثاث بجدة رائعة لتلبية طلبات العميل. فرؤية الشركة لدينا وضعت طريقة جيدة وضعت كخبراء في نقل الخدمات التي يحتاجها العملاء عند التعاون مع شركة نقل عفش بجدة فاختيار المواد الخاصة بك التي تستخدم في تغليف الاثاث فهذه المواد أو الأشياء ستكون موجودة على عتبة المنزل للتحرك بكل آمن و بقوة إلى المكان الذي ترغب فيه
شركة نقل الاثاث بالدمام
استخدام الأصول الأولى داخل الاستراتيجية التي تستخدمها شركة نقل عفش بالدمام لدينا تدفعنا إلى التفكير في إعطاء نوع من الخدمات المتميزة الي العملاء التي تترك نجاحا مباشرا يمكن أن تنقش على نفسية الزبائن التي تقدم لهم خدمة نقل العفش.فلدينا ميل إلى أن يشار جيدا إلى العاملون والفنين والمغلفون ان يقوموا بعملهم في شركة نقل اثاث بالدمام نتيجة للمعيار والتنمية والعقل
شركة نقل الاثاث بمكة
مجموعة معينة لدينا في شركة نقل عفش بمكة تساعدنا في خدمتك في أي وقت من اليوم، وأنهم على استعداد للبقاء على طول هذه الخطوط لاعطاءك خدمة متميزة عن باقي شركات نقل اثاث بمكة التي توجد بهذه المنطقة فلا أحد لدينا في خدمات النقل يترك شيئا حتي لا نقع في قليلا من السخط.
شركة تخزين الاثاث بالرياض
التعبئة والتغليف يبدأ بالعمل المتميز من اجل الحصول علي شركة تخزين عفش بالرياض متميزة تمتلك مستودعات تخزين اثاث بالرياض تحافظ علي الممتلكات الخاصة بكم من الخراب. كما ان التعبئة والتغليف على استعداد فريد للتعامل مع كل نوع من الأدوات والأشياء الزجاجية والمواد التي تميل إلى الإضرار أو تحمل بانتظام أسوأ جزء في عملية الحركة. فخدمات شركة تخزين اثاث بالرياض تقوم بإرسال أفضل مجموعة يتقن الوصول إليها في الوقت المناسب لتلبية طلب العميل وفقا لمتطلبات محددة خاصة بك في هذا المجال بسبب الطريقة التي كانت لدينا مجموعة من الخبراء في كيفية ادارة مستودعات تخزين اثاث منذ فترة طويلة في هذه الصناعة لفترة طويلة جدا.
شركة تخزين اثاث
شركة تخزين عفش