This article is a guest contribution from David Rosenberg, Chief Market Economist, Gluskin Sheff.
THE CASE FOR BONDS
In the discussion about the outlook for U.S. Treasury bonds, the point must be emphasized that supply alone has been an inadequate focus for predicting future price/yield. You don’t have to do much more than to go back to examples like these: the 30-year Treasury bond yield went from 4.7% to 6.7% in 1999, even though bond issuance by the Treasury was practically nil. And, the decline in JGB yields over the last 20 years, even though deficit spending has been spectacular in Japan and debt-to-GDP is approaching 200%. The last I saw, the 10-year JGB yield was at 1.2%.
The problem with trying to assess either supply or demand in the current market environment is that everything is so confusing in the early stages of this new secular paradigm of a global credit collapse. There is no way to get it completely right. As Lacy Hunt has always maintained, it makes much more sense to assess the outlook for inflation as the primary effort in predicting Treasury rates. Simple and elegant. Maybe perhaps instead of inflation, we should really be discussing deflation, which has emerged as the primary trend, and governments have few bullets left in the chamber to deal with it.
Bond yields have been low for some time, and they will remain low. But don’t be lulled into numerical micro-phobia (the fear of small numbers that plagues the bond bears). The near 30% slide in the Chinese stock market suggests that we have three to six more months of deflating commodity prices. And, if the trend in Japanese, German and Swiss yields are any indication, bonds in the United States and Canada have plenty of room to fall further.
