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The State Of The Bond Market As Trump Ascends To POTUS

Date: Sunday, January 1, 2017 2:04 PM EST

In this new year, we should look at the state of the bond market as Donald Trump ascends to the presidency. Some have said that the bond market bubble is about to burst. Some say China will sell a massive hoard of bonds as a trade war is initiated by the Donald. But I am not sure that would help China in a time where it needs bonds to appreciate in value.

The market for bonds has kept up even with massive bond auctions after the Great Recession. Revenue fell massively. Federal revenue fell again this year after recovering since 2008. But this decrease is small change compared to what happened in the Great Recession.

So, what are the issues in attempting to determine the bubble/no bubble status of long treasury bonds? Here and here are a few:

1. China could sell bonds in large quantities, since it holds over 1 trillion dollars of US government debt. Supply of long bonds could greatly outpace demand for those same bonds, at least for a time. Would China ever seek to destroy a major trading partner? It is unlikely. 

2. Demand for long bonds has been massive. As David Beckworth, economist, has said, the demand for bonds has been massive because of a safe asset shortage. The Great Recession decreased private safe assets, as they were no longer considered so safe. Excess demand for public safe assets has increased since the crash. Treasuries, repos, agencies and new commercial paper have replaced the failed private MBSes as money supply in the shadow banking money markets. They function like money. They are often used as collateral, for making loans and deals.

Shortages of these financial assets cause fewer deals and loans to be made. The study of repo fails has been center of research by Talkmarkets' Jeffrey P. Snider.

Beckworth shows us a study done by MIT,  Harvard and U.C. Berkeley by economists Caballero, Farhi and Gourinchas, which shows that central banks cannot push natural rates (r*) too far negative. The article is titled Safe Assets and Aggregate Demand. The failure of central banks to push rates lower results in an interest rate gap emerging, which will cause output to fall below its potential. This impact on aggregate demand has slowed the normal business cycle. By the way, the economists say that physical assets are simply not safe assets.

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