The reality appears to be, it’s unlikely. Yes, an individual country like Greece can suffer a huge bond scare, but for larger nations with printing presses such as the US and Japan, the most likely outcome is simply more debt and more devaluation. And with plenty of money sloshing around chasing too few assets, bonds will probably continue to be bid. The only thing that would reliably kill the bond market is higher interest rates from central banks. The trouble is, higher rates would also kill the market for everything else and trigger a depression. Could an inflation scare occur? Demographics, unproductive debt, and technological advancements put the chance of a sustained period of inflation pretty low, despite (or because of) the best efforts of Central Bankers.
# Baby Boomers are compounding the problem.
As we noted in The Hack on April 7th, ‘Baby Boomers Coming of Age’, the backdrop of an ageing demographic and massive pension black holes will structurally cap any rise in interest rates.
‘According to the Federal Reserve, unfunded state and local pension obligations have risen to $1.9 trillion from $292 billion since 2007. Throw in the private sector and that figure is far greater. At the same time pension funds have been pushed up the risk curve as interest rates from fixed income are simply inadequate. Baby Boomers have never been more exposed to equities and are going to start to drawdown their capital for retirement.’
The paradox is this: To fill that black hole and provide fixed income for retirement, we need bond yields above, say, 5%; but with yields above 5% the ability to service the debt mountain collapses and assets are liquidated. Wealth is devastated. Then, all those retirees will be shifting assets from equities into fixed income in the next decade, driving a huge wall of money into a bond market with diminishing yields.
# What about cyclical considerations?
We have been stating for some time that the credit cycle is rolling over. Just last week Michael Lewitt noted:
“I no longer expect interest rates to rise significantly from current levels in the current cycle; they are more likely to fall as the economy stays weak and debt continues to build in both the public and private sectors. We could see short-term 25 or 50 basis point spikes in longer rates (10–30 years) based on an errant comment by a central banker or some piece of news, but rates are likely to stay down until the current business cycle, which is very long-in-the-tooth, ends.”
With the Fed raising rates into a slowdown, they will have to backpedal in the near future to soften the economic blow.
# How low can we go?
The limbo continues, and the bar goes lower. For now, it is hard to see any alternative to more debt and lower rates. The inflection point where we could grow our way out of this debt straight jacket has passed.
The secular low in interest rates appears to still be ahead of us.
# Velocity of Money (M2); M x V = P x T. Thinking in a new direction....