By Michael Lombardi, MBA
The bond market is in trouble.
As we all know, the Federal Reserve has been the biggest driver of bonds since the financial crisis. The central bank lowered its benchmark interest rate to near zero, then started quantitative easing, all of which resulted in the bond market soaring as yields collapsed to multi-decade lows.
The chart below will show you what has happened to the U.S. bond market since the mid-1970s.
As you can see from the chart, the declining yields on bonds stopped in the spring of 2013 and have increased sharply since then.
Chart courtesy of www.StockCharts.com.
What's next for bonds?
The Federal Reserve is slowly taking away the "steroids" that boosted the bond market. The central bank is now printing $65.0 billion of new money a month instead of the $85.0 billion it was printing just a few months back. And now we hear the Federal Reserve will be slowing its purchases by $10.0 billion a month throughout 2014.
Since May of last year alone, when speculation started that the Federal Reserve would cut back on its money printing program, bond yields skyrocketed and bond investors panicked.
According to the Investment Company Institute, investors sold $176 billion worth of long-term bond mutual funds between June and December of last year. (Source: Investment Company Institute web site, last accessed February 26, 2014.) I would not be surprised if withdrawals from bond mutual funds are even bigger this year.
And China is slowly exiting the U.S. bond market, too. According to the U.S. Department of the Treasury, in December, China sold the biggest amount of U.S. bonds since 2011. In December, the country reduced its U.S. bond holdings by $47.8 billion, or 3.6%. It now holds $1.27 trillion worth of U.S. bonds. (Source: Bloomberg, February 18, 2014.)
When I look at the bond market, I only see risk. The Federal Reserve - the key backer of lower bond yields over the past five years - is pulling back on its money printing program, which was what had fueled the bond market's rally in the first place. And we have China pulling back on its holdings of U.S. Treasuries, too. So, who will buy U.S. Treasuries if both the Fed and China are pulling back on buying them? Won't rates on bonds need to rise in order to attract more buyers to them?
I'm afraid the bond market is setting up for an imminent sell-off. And while many retail investors take the bond market lightly, a falling bond market will have a massive negative impact on the stock market and the housing market - a caution for investors.