In the age of improving macroeconomic data does Bernanke still matter? It would seem no, if you watch the market reaction in the last two months. However, I liken the market to a young kid living in central Manhattan, kidding himself he is living on his own just because he pays for his meals, while the reality is his father is the one who is covering the real bill that matters, the rent.
We had a steady stream of news recently that the zero interest rate policy, ZIRP, pledge until 2014 does not mean they can't raise the rates until then. However, I have a problem believing that, as Bernanke himself wasn't on any of those news reports. You might or might not like him but one thing Bernanke deserves credit for is his transparency. Right through the crisis he always stood behind his word. His actions and decisions were not unanimously liked or approved by the financial community at large, but he always did a good job of communicating his decisions to the markets.
His decision to keep the ZIRP policy until 2014 was somehow unexpected, but Bernanke doesn't strike me as a person that will make a strong pledge like that just to give a quick jolt to the markets. In my opinion, he really believes, and correctly realizes, that what keeps the market alive is his QE and ZIRP policies. He anticipates that the macro data is improving because his policies have improved the equities market. However, he won't be able to pull the plug on the easy money until at least 2014, because the market would reverse and take down the macro data with it. That kind of action would negate the reasoning for cancelling the ZIRP policy anyway. So Bernanke does the smart thing. He comes out and states the obvious to at least benefit from the stability that kind of a pledge will bring to the markets. Did the Europeans land on sort of a free lunch with that statement? Absolutely. Did Bernanke want to give that free lunch to the Europeans? For sure. However, one thing he didn't do is to give a promise that he doesn't intend to hold. Add to this that he is the only one whose opinion truly matters when making the decisions, and it doesn't seem like a good idea to fight the Emperor.
In that context, how should you play the bonds? In my opinion the band between 2,0% - 2,1% on the 10-year Treasury yield will be the upward boundary for the near future. I base that argument on a couple of reasons. One of them is if you do a DCF simulation that the rates will be near zero for another 2 - 2,5 years than will gradually increase to 5% over the next 5 years and then will abruptly decrease back to 0,5% - 1,5% and stay there for the last 3 years as another bear market probably hits, the IRR on that simulation comes roughly to a little above 2%. This simulation is a very likely sequence of events in my opinion. This should be quite close to what the bond market is forecasting also as the 10-Year yield has had a difficult time climbing back above 2,1% even in the context of a wildly rising equities market (QQQ).
The other thing about the bonds is that, as frequently mentioned, the Bond market is in a bubble fueled by the ZIRP policy. However, a chart of the 10-year Treasury prices does not seem to indicate that the bubble has entered is truly exponential state yet. Another way of explaining this thesis is whenever the equities market shows signs of improvement the bonds sell off. That is not indicative of the last stage of a bubble when the asset in question will rise in price disregarding all the obstacles to its ascent. Also as mentioned earlier there are no indications that the fuel that burns the bubble, the easy money, will abate in the near future.
As a trade idea I suggest that a good percentage of a portfolio can be kept, with even some leverage in the (IEF),(TLH) and (TLT), the iShares long-term Treasury ETFs. However don't take this long argument about the Treasuries as a sign to short the equities market (DIA), (IWM). What will likely happen is the equities market will start to rise after a mild correction until mid-May 2012 and the 10-Year Treasury yield will hover around 2,0%, when there will be another shock. That will correct the market strongly and there will be a sharp decline in bond yields from 2% to 1,5% -1,6% area which might mark the top of the bond bubble and a sign to get out.
When you make your financial decisions don't get fooled by the little things. What matters the most is who pays the rent, not the latte on the way to work. For the markets Bernanke is the one who still pays the main bill. You might not like him but at least he is honest about his intentions. That is a hard to find quality these days. So you might want to take his word when he says ZIRP is here to stay until 2014.
