The Coming Bond Market Collapse

The global bond market will collapse. One of the biggest bull markets in history has turned into one of the biggest bubbles in history.

The story begins in the 1970’s. Inflation is rampant. Prices are moving sharply higher. Gerald Ford wears a WIN button. Whip Inflation Now.

Money supply has been growing out of control since Richard Nixon took the US off the gold standard in 1971.

Mortgages are pushing 20%! Short term interest rates are over 20%!

6’7” Paul Volcker is hired to head the Federal Reserve System. Dramatically, he raises interest rates and stops increasing the money supply over night. The world is shocked! Central bankers are supposed to be prudent sober individuals not people who make dramatic moves.

But he did.

And thus the greatest bull market in bonds in US history began. Inflation came down. Interest rates came down. For 37 years!

Short term interest rates have effectively reached zero and long term rates to below 2%. As interest rates come down, bond prices rally. They are inverse.

But the Big Bull is over. Interest rates are now about to rise and rise dramatically. Here’s why.

For inflation to occur, several things have to happen.

First, the Fed has to increase the size of their balance sheet. They have tripled the size since 2008 which gives a massive base for money supply growth which should then lead to higher inflation.

But the increase in the base never translated into inflation. That money didn’t go to increasing debt to the private section but went almost exclusively into buying Federal government debt. So the increase never made it to Main Street so no inflation so no higher bond yields.

But this is changing. Inflation is coming back and this will cause long term interest rates to rally thus causing bond prices to collapse.

The global economy will be much stronger in 2017. I’ll write why in another column. The stronger economy will cause higher inflation and money to flow out of the bond market.

The stock market will also be stronger than the bond market and massive money will flow out of the bond market and into the stock market. This is already happening on a large scale.

Investors will want the higher returns of the stock market and will panic sell bonds to cut their losses. Stock mutual funds will show profits while bond funds will show losses and retail investors will shift their money to bonds from stocks.

Basically, we are coming into a perfect storm for bonds. Inflation is coming back. Money flows are turning negative.

The bear market won’t be straight down but we must always be looking for reasons to short the market.

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