With the rate on the 10 year Treasury up around 50 basis points over the last month, many prominent bond investors (including PIMCO's Bill Gross) have called an end to the decades long bond bull market. Judging by his presentation earlier this week entitled "What in the World is Going on?" bond guru Jeff Gundlach may not agree. Here are 3 reasons he thinks interest rates aren't headed much higher from here.
Reason #1: Global Growth is Slowing
Bond rates generally rise when growth is rising, causing inflation expectations to pick up and investors to demand a higher rate of return to compensate. In slide 9 of his presentation, which you can see below, Mr. Gundlach shows that in fact the opposite is happening. After the initial uptick after the financial crisis, global GDP growth has been in a steady downward trend.
As you can see in the chart below, GDP forecasts for all areas of the world in 2013 also continue to fall, meaning that economists are getting less not more optimistic about future growth.
Click to enlarge
Reason #2: Inflation Expectations are falling again
To see what the market's future inflation expectations are, traders often look at the 10 year breakeven rate, which subtracts the yield on a 10 year TIPS from the yield on a 10 year Treasury note. As you can see from the chart below, inflation expectations have not been heading higher along with the 10 year treasury yield. In fact after peaking at over 2.5% earlier this year the break even rate has dropped to around 2.19% today.
Reason #3: The Fed is Not Going to Let Interest Rates Rise Much Higher
One of the biggest reasons the many have turned more optimistic about the US economy is that the housing market, which was at the center of the financial crisis, has started to turn around. One of the primary reasons why is that interest rates on mortgages have been at very low levels, making houses much more affordable for the average buyer.
However, as you can see in the slide below mortgage rates have spiked substantially over the last month from a low of around 3.5% to around 4.3% today. In Mr. Gundlach's opinion the Fed is likely to step in and actually increase QE to try and hold rates down if we see interest rates head much higher from here.
What does this mean for investors?
It means that the case can still be made for being long treasuries through instruments such as IEF and TLT, as well as the overall bond market through total bond market ETFs like BND. It also means that those who continue to call for a top in bonds and who are short the market through instruments like the TBT ETF are likely to get burned again.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.