The bull market in bonds is an unintended consequence of ZIRP (Zero-Interest Rate Policy) and will likely continue as interest rates remain at zero. The most germane example is Japan. In 1990, 10-year JGBs were north of 5%, but as the BOJ cut rates and implemented ZIRP, 10-year JGBs now only yield 0.94%. Japanese investors faced the same pressures as Americans today. They want to generate a decent rate of return while ensuring a safe portfolio. Was Japan's bond market a bubble? No, but it did ruin a lot of smart hedge fund managers who tried to short JGBs, most notably Julian Robertson. They could not understand how an over-indebted country could have such low interest rates on government bonds. What they failed to understand was that the JGB market was being distorted by ZIRP. The BOJ's key discount rate has been held at less than 1% since 1995 and below 0.50% since 2001. This was not the free market but the result of central bank intervention. Japanese investors were forced into bonds because they had little choice. Were they going to invest in the Nikkei, which had fallen from 38,000 in 1990 to 10,000 currently? Property was not an option either, considering the persistent decline in prices. Holding money in a bank deposit was pointless as you got 0%. Under these bleak investment options, JGBs yielding a risk-free real rate of return of 1-2% looks pretty good. The only other choice was trying the incredibly risky carry trade that blows up every 3-5 years.
I fear that the US is on the road to following Japan's lost decade. It's interesting; the Fed constantly declares that we will never go the way of Japan, but they have adopted all of the Bank of Japan's failed policies: ZIRP, QE, an unlimited liquidity facilities to the banking system. All of these actions disrupt the free market and obfuscate economic reality. In a free market where interest rates are set by the market, rates would never be at 0%. But we live in a market that is no longer free and is the result of massive government and central bank intervention. That is why oil is $80, copper at $3.40, and 10 year treasuries at 2.6%. Are these sustainable? It depends how long the government continues to manipulate the market. As we saw in the case of Japan, these paradoxes can last longer than you can stay solvent. In the US markets are no longer an arbiter of truth or reality.
Black Swan Insights
another year another bubble.
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