The news is gloomy for stock investors. Shares have been plummeting as traders absorb the latest information about the coronavirus’s spread around the world.
Most commodity markets have been miserable too, with the prices of oil, gas, coal and copper falling relentlessly.
But if you focus on the bond market — which doesn’t dominate the headlines but is much bigger than the global stock market — you will get a different and more complex picture. And if you own bonds, they have probably been growing rapidly in value.
The reasons for these paper profits are disconcerting. The bond market isn’t merely reacting to the coronavirus: It is reflecting a perception that the global economy was vulnerable long before the disease emerged, because financial markets have never fully recovered from the last financial crisis.
David Rosenberg has been tracking the bond market for decades. He is now the chief economist of his own firm, Rosenberg Research. Until 2009, he was chief North American economist for Merrill Lynch, and he takes a very long view. “If you had told me a decade ago that bond yields would be this low now, it would have been shocking,” he said.
“Basically,” he added, “interest rates have never returned to where they were before the last recession. They’ve kept dropping. We’ve been in a long secular bull market for bonds, and it’s not over yet, not by a long shot. Rates are going lower.”
I think he’s probably right. Which means that it’s likely you can make more money in bonds, even at this late stage of a decadeslong rally.
But it also means that we are living in a strange new world, one in which financial markets are being stretched in ways that scarcely could have been comprehended a decade ago.
This has not been a market rout for bond investors.
The headlines have focused on the cascading losses in the stock market over the last week or so. But that has not been the case for bonds.
To the contrary, it has been a time to reap astounding profits from bond holdings. And for buy-and-hold investors who have kept both stocks and bonds, it has been a reminder that those boring bonds can offset painful stock losses, making it easier to hang on for the long run.
Consider these numbers:
By Friday afternoon, a fund that tracked the investment-grade long-term U.S. bond market — the Vanguard Long-Term Bond ETF — generated a 7.8% return so far this year. But in the same stretch, a fund that tracked the S&P 500 stock index — the SPDR S&P 500 ETF, or SPY — fell 9%.
Long-term bonds have also outstripped stocks over the last 12 months. In that period, the stock fund returned 7.5%, but the long-term bond fund gained more than 26%, a staggering return for an asset category often thought of as dull.
Bond prices have risen sky-high because they move in the opposite direction of interest rates. And rates for the benchmark 10-year Treasury note have dropped to levels that have never been seen before. On Friday morning, for example, the rate for the 10-year note dropped as low as 1.15%. Rosenberg expects that it will fall even further.
Great as bond returns have been, it is difficult for a thinking person to rejoice.
The bond market has been conveying truly disturbing messages, not just about the current state of the economy but about the world’s inability to recover entirely from the last recession and our vulnerability when the next one comes.
Recall the downturn set off more than a decade ago by the global financial crisis. That recession started in the United States in December 2007 and ended in June 2009, according to the official arbiters at the National Bureau of Economic Research.
The ensuing economic recovery has been the longest in American history, yet it has been one of the feeblest as well. One indication of that can be seen in the bond market right now. Interest rates typically fall when the economy is weak but then rise, along with inflation, in periods of rip-roaring growth. But that is not the pattern we have seen over the last 10 years.
Both the short-term rates controlled by the Federal Reserve and the longer-term rates determined by the bond market did drop sharply, during and after the last financial crisis. But since then, inflation has remained low, the rate of economic growth has been modest and interest rates have never returned even close to their prerecession levels.
The 10-year Treasury note in 2007 was as high as 4.85%, Treasury data show. It hasn’t been much above 3% in the last five years. And the federal funds rate, the short-term interest rate set by the Federal Reserve, reached 5.25% in 2006. It rose to only 2.5% in 2018 and 2019, and now is in the 1.5% to 1.75% range, according to the Fed.
Rates this low, this long, are not normal.
The United States has entered dangerous territory, a paper published last month by the Federal Reserve emphasized. The paper, written by the Fed economist Michael Kiley, said that the current low level of rates will cause severe policy dilemmas when the next recession actually hits.
Historically, interest rates tend to decline significantly during recessions and for two years afterward, Kiley wrote. But with rates as low as they are now, he said, “simple arithmetic” shows that in a recession, both short-term interest rates and those for bonds will approach zero — or even be negative. That, he said, will bring the “U.S. experience closer to that seen in Europe and Japan,” where many long-term bonds are already paying negative interest.
This amounts to the kind of proposition expected from gangsters: Hand me your money, watch me skim off some of it and you get what’s left later. Yet it has become commonplace in the global bond market.
That might not happen in the United States, Rosenberg said, because of “legal and logistical constraints.”
“Negative rates are a tax on money,” he said, “and it’s one thing to have them in Japan and Germany, but something else entirely when you’re talking about the world’s reserve currency, the dollar.”
Essentially, with negative rates, people would be paying money for the privilege of sheltering their funds in the United States bond market. Could that happen? We may soon find out, as interest rates drop during the coronavirus crisis, which appears to be sapping economic growth around the world.
A recession will come sooner or later. Whether we are seeing the beginnings of one now or just a precursor of an eventual downturn is impossible to know. But bonds are not merely providing a comfort for investors. They are issuing a warning of even more difficult times ahead.
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February 29, 2020 at 08:52PM
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There were some profits in markets last week, but they came with a warning - Minneapolis Star Tribune
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