This morning, I read Skyler Greene's article, Double Bottom In 30-Year Treasury Yields: End Of The Bond Bull Market?
While I feel the article brought up some very interesting points, I respectfully disagree with the conclusion, and believe that treasury yields have more room to fall. I'd like to add that Mr. Greene is an excellent contributor, and I'm a follower of his. I'm simply taking the other side on this one.
The Technical Picture
The following graph from Skyler's article illustrates the potential "double-bottom" in 30-year treasury yields:
I think this is an interesting picture, since the two price points show the low yields at important economic inflection points. One of course being the financial crisis, the other being today's structural debt issues and the subsequent lack of quality assets.
However, let's take a look at a recent graph from The Big Picture of actual 30-year yields:
Note how many times it appeared an important double-bottom was occurring. Additionally, whereas the chart action during the financial crisis reflects capitulation and panic, today's movements merely illustrate a strong bull market with a healthy consolidation towards the end of 2011 and early 2012.
Lack Of Quality Assets
Rather than an indication of inflation expectations, credit worthiness, etc., today's bond market (TLT) reflects a lack of quality assets.
The world's pension, insurance, investment, endowment, sovereign wealth, and a multitude of other funds have trillions of dollars that they need to invest in low-risk, quality assets. Although I am a proponent of holding physical gold as a portion of your private portfolio over the course of a lifetime (note: I'm bearish on gold in the medium-term), these kinds of funds are looking for assets with real, stable yields.
Before the European crisis, many funds happily held all sorts of European peripheral sovereign debt, whether it be Portuguese, Spanish, Italian, Irish, even Greek. Many funds got involved in the highly-yielding universe of MBS and other CDOs. Equities were also considered to be more stable, with investors psychologically reinforced by the lack of a major bear market (2004-2007).
Today, with investors still fearful of another Lehman-like event, most major funds have markedly reduced their equity and CDO holdings, piling into highly-rated corporate bonds, AAA sovereign debt (AA in the USA's case), and the like. Today's record low yields reflect that dynamic.
Supply Of Quality Is Diminishing - The French Example
I expect quality assets to dry up even further. Take French debt for example. While the official debt to GDP ratio is 86%, adding in all liabilities (including Eurozone obligations) the true ratio is probably near 150%.
Furthermore, France's banks have a ton of exposure to Italian and Spanish debt, so future bank recapitilizations are not out of the question at all.
Most importantly, the election of France's new and heralded socialist leader Hollande is a clear admittance that the country has no tolerance for any sort of sustainable policy. With the minimum national retirement age being cut by two years (to 60), France's budget issues (they have an annual deficit in excess of 5%) are going to get worse.
There is a major drive to raise taxes on the wealthy and corporations, but with the wealthy already paying about 70% in taxes, the incremental effect on collected revenues is likely to be muted. France is repeating the same mistakes as the peripheral nations, and over time, their debt is going to continue to become much less attractive.
How about the trillions of capital allocated in US municipals?
US local debt issues are starting to crack a bit, with major bankruptcies in Stockton, Scranton, and a few others. Moody's is beginning to wonder if cities are simply treating interest payments as discretionary items, and using bankruptcy as a way to "extract concessions from" public employees, bondholders, and the like. The muni market is likely to deteriorate further, especially when one considers the declining trend in US GDP. Years of ultra-low tax receipts are catching up to many distressed muni issuers.
The capital reallocation process will happen slowly, but yields of German bunds, US treasuries, and highly rated corporates will continue to fall as holders of French debt and many US municipals begin to refuse the inherent risk of holding the issues.
Though some believe the so-called put is in the equity market, the real floor is in the bond market. With the implicit assurance that treasuries will be bought up if yields rise to an unacceptable level, Bernanke has gotten a ton of investors to frontrun him. By ensuring the public that bond prices will always go up (and they have for the last few decades), investors are simply refusing to give up their ever-appreciating treasury holdings.
Analysis of the real rate of return is meaningless regarding treasuries. The yield is better than holding cash, and with the implicit guarantee to print money to pay its debts, treasuries are still the main safe-haven. I of course disagree that they're safe - the very dollar's that they are denominated in will continue to be printed en masse and they're worth relative to real assets will continually decline. This is however the way the world allocates capital, and it will remain so for quite some time.