The Bond Market Has Reached Tulip Bubble Proportions

Fed Officials Trying to Send Signals to the Bond Market

James Bullard on Friday noted that the Bond Market was far too dovish in relation to where the Fed is in regard to raising rates in June, and this might be the understatement of the year so far. For example the U.S. 2-Year Bond Yield is 0.45 or 45 basis points. Think about this for a moment. Even if the Fed fund`s rate finishes the year at 50 basis points, which is well below the Fed's most conservative forecasts, and we use a conservative annual inflation rate of 1% (I know oil has dropped, but there are more inflation categories than just the energy component). Moreover, the overall annual inflation rate is well above 1% right now, and when you factor in that this bond is paying a 2-year risk premium for tying up one's capital with all kinds of inflation risks over that 2-year time frame, this has to be the stupidest investment of all time. 

2-Year U.S. Bond Yield is 45 Basis Points

When the Fed has practically stated that after two FOMC meetings they are liable to raise rates at least 25 basis points at the earliest (think April) and June at the latest,  that is 25 basis points right there added to the Fed Fund`s rate, and needs to be added to the 2-Year Bond calculation. The current Fed target rate is 0.00 - 0.25 with the daily rate on 1/29 of 0.11 or 11 basis points, so add the June 25 basis rate hike to the current daily rate of 11 basis points and you get a 36 basis point starting point for borrowing money. Add an annual inflation rate of 1%, and we are at 136 basis points for evaluating the 2-Year Bond given this rather charitable and conservative analysis.

Read More: European Bond Market: Bubble of all Bubbles


June Rate Hike Telegraphed to Markets

Remember, this June rate hike by the Fed has been pretty well telegraphed to market participants, and nothing changed in the latest Fed Statement. In fact, it became even more hawkish with language changes in the statement released this week. Therefore, whether or not one completely takes out the inflation component leaving a 36-basis point starting point, a 45-basis point yield on the 2-Year is beyond absurd. It is an example of just how much risk taking and froth there is currently in the bond markets due to so much cheap money sloshing around the financial system right now. The only way an investor can make money with a negative real rate of return, if you factor in the inflation rate, is by using an insane amount of leverage on these very low borrowing costs. Low borrowing costs aren't enough to make this trade work, it takes huge scale to make this a "worthwhile trade" in a negative real rate scenario that this trade offers up to the risk taker. 

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Sensible Cents 6 years ago Member's comment

Jan 14th 20yr treasury broke out to all new highs. so if breaking out now no way even close. Breaking out is not a bubble.

Carol W 6 years ago Contributor's comment

The Fed is not raising rates while Obama is still in office. The CEO from CAT waved a huge red flag on the fragile US economy.. The german bonds are a joke. Euros will buy our bonds. Bill Gross said the TLT is the trade of the year. Equities might suffer a tad. but bonds? Hardly a tulip scenario..cheers!