We’ve Got a Bond Bubble of Epic Proportions

Graham Summers of Phoenix Capital Research asks Forget Stocks, What Happens When the Bond Bubble Bursts?

…the numbers don’t lie, we are most assuredly in a bond bubble. According to data compiled by Bloomberg and the Washington-based Investment Company Institute, investors have put almost as much money into bond funds in the two years ended June 2010 ($480 billion) as they did in equity mutual funds at the height of the Tech bubble from 1999-2000 ($496 billion).And the insanity is literally across the board for bonds.

Treasuries are trading at levels not seen since the depth of the 2008 Crisis. We just had a TIPS auction close at a negative yield for the first time in history, meaning investors are willing to LOSE money just to park it with bonds that supposedly adjust for inflation (TIPS adjust based on the CPI which is nowhere near the REAL rate of inflation… see tomorrow’s essay for more on this), and US corporations have ALREADY issued $217 billion in junk bonds this year, even HIGHER than last year’s RECORD.

In plain terms, we’ve got a bond bubble of epic proportions on our hands. And if you think a stock market crash is something to behold, wait until the bond bubble bursts.

Remember, we’ve been in a bond bull market for well over 30 years. And while stocks have experienced at least three Crashes during that time (1987, 2000, and 2008), bonds have generally done nothing but go up over that period.

Because of this, there is an entire generation of professional traders/ analysts/ fund managers who have never invested during a bear market in bonds. These folks have made their entire professional careers investing with the basic understanding that debt is cheap and bonds overall move higher.

As we’ve seen with tech stocks, real estate and other asset bubbles in recent decades, nothing goes up forever.

With interest rates near historical lows, and often times going negative as they did with TIPS bonds over the last week, it is clear that many investors are actually willing to earn no interest on their loans to the government and pay the government to keep their money safe.

But as The Federal Reserve monetizes more Treasury debt and foreign creditors look for ways to exist US debt instruments, there is only one direction for bond price to go in the long term.

They eventual bust of the bond bubble will lead to higher interest rates on loans to the government, but likewise, will lead to higher mortgage rates and loan rates for consumers across the board, making it even more difficult to obtain credit and keep consumption ramped up.

In a worst case scenario, it has been postulated that a bursting of bonds could come at the same time as a complete collapse of the US Dollar, triggered by a loss in confidence and flight out of the dollar by foreign and domestic investors alike. The result of such a scenario has been theorized to be significantly hyperinflationary in terms of asset prices.

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