Content By: The Coming Depression Editorial Staff (dates cited below)
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quantitative easing bond market

“Depending on the size of the asset purchasing program during the November 3rd, 2010 FOMC meeting, a large QE2 could push bond yields higher and push prices lower over the long-term. This is as a result of investors demanding a higher yield over time due to a large asset purchase program leading to a higher expectation of inflation.”

Indeed, yields are 2.47%, Bond market money is at full tank, and Obama is pumping hundreds of billions more into it. This is driving yields to record lows and US dollar down with it. Indeed, investors are going to buy Gold, Silver and other hard assets to hedge against the massive exit of bond holders. Investors have been flip flopping between Bonds and Gold for the past 100 years and will do so again. It just takes about 30 years (ie. 30 year Govn’t Bond) to repeat the cycle again. We should all remember 1980 and 1929. Respectively, the bottom in the bond market during 1981 and the subsequent upside breakout in 1982 helped launch the major bull market in stocks that began the same year. IN 1929, according to futurecasts.com, “in the first 10 months of 1929, there was $9.2 billion in new securities issued. This was 30% more than in any previous 10 month period. Yet, so great was the flow of credit capital into New York that the supply remained capable of meeting all demands. In September, 1929, speculators could borrow at rates ranging from 8% to 10% and, from and after the first week in October, 1929, at 7% and less.” Consequently we all know what happened to these 2 bond market runs (crashes).

bond market bubble chart

The bond market has always been larger than the stock market. Using wikipedia (and the fact that the numbers are very volatile due to the crisis), it appears that the bond market is 2x-3x times larger than the stock market. Thus, the money injection needs to be 2x-3x times larger to really be compared to 1999-2000.

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And then there’s also the fact that they are so many factors at play. People might plow into bonds because they are risk adverse, or because they want to rebalance their portfolios. And even if bond prices “collapse”, they won’t fall more than 5%-10%. It’s not like stock prices that go to zero. You only possible problem might be in the really long duration bonds. If you hold a high quality bond, you have little to fear.

Is the U.S. Bond Market in a Bubble? by Jason Chen

For many investors, this is a key concern, especially as the global economic recovery is still unstable. There has been rising speculation that the Federal Open Market Committee (FOMC), the component of the U.S. Federal Reserve that determines monetary policy, will announce quantitative easing 2 (QE2) during their next meeting on November 3rd, 2010. This means the U.S. Federal Reserve will pump huge amounts of newly printed money into the economy by purchasing assets such as government bonds, a move that could push yields even lower for bonds. More details on what kind of assets are to be purchased will be revealed in the FOMC meeting if they move ahead with QE2. Recently, Goldman Sachs speculated the Fed could pump a total of $2 trillion into the U.S. economy if QE2 is announced.

Governments and corporations issue bonds as a way of acknowledging debt. A bond can be referred to as an IOU, abbreviated from “I owe you.” They are generally considered to be less risky than stocks. Presently, a total of more than $2.2 trillion has been invested in bonds by public investors through mutual funds. Last year alone, $375 billion was invested into bond mutual funds as investors looked for more stability and preservation of capital in the depths of the stock market crash. A further $230 billion was invested into bond mutual funds this year. That makes a total of $605 billion invested in bond mutual funds since the start of 2009.

Depending on the size of the asset purchasing program during the November 3rd, 2010 FOMC meeting, a large QE2 could push bond yields higher and push prices lower over the long-term. This is as a result of investors demanding a higher yield over time due to a large asset purchase program leading to a higher expectation of inflation. There is an inverse relationship between yield and price because the bond’s net present value uses yield as the discount rate. Why does this matter? Bondholders may or may not understand this, but there are risks to holding bonds. The most noteworthy of this is inflation risk.

More resources:

QE2 risks currency wars and the end of dollar hegemony
As the US Federal Reserve meets today to decide whether its next blast of quantitative easing should be $1 trillion or a more cautious $500bn, it does so knowing that China and the emerging world view the policy as an attempt to drive down the dollar.

Get a free 10 page report from Robert Prechter about the bond market conundrum.

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