David Moenning

About the Author David Moenning

David Moenning is a the Chief Investment Officer at Heritage Capital, which focuses on active risk management of the U.S. stock market. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Dave began his investment career in 1980 and has been an independent money manager since 1987. Thus, Dave has been live on the firing line and investing for a living for more than 25 years.

The Current Macro Picture May Not Support a Quick Death of the Bond Bull

Ever since the Credit Crisis calamity that occurred between late-2007 and March 9, 2009, a great many investors have begun to embrace a macro approach to the markets. From a big picture standpoint, the idea is to take a stance on the macro view of the world and then invest accordingly. The hope is that using such an approach will allow investors to foresee the next big problem before it attacks their portfolios.

To be sure, this sounds like a grand idea. If the world begins to fall apart at the seams, why not take defensive measures ahead of time, right? The problem is that “getting it right” on a consistent basis is much harder than it looks!

Case in point would be the mega bear in the bond market that analysts have been calling for since the Fed began talking about removing the monetary stimulus they have been providing the economy for going on seven years now.

But, with the exception of 2012, bonds have continued to provide investors with a steady stream of income and a decent degree of stability whenever a new crisis reared its ugly head.

Yet, the bond bears remain resolute in their conviction. “Just wait,” we’re told. “Things will get very ugly in the bond market when the Fed starts hiking rates.” And with Yellen’s gang talking openly about lifting rates in December, isn’t it time to worry about bonds?

There can be no arguing the point that bond prices will indeed fall when rates rise. And with the Fed inching ever closer to the “liftoff” from ZIRP (zero interest rate policy), bond bears appear to be licking their chops at the prospect of their long awaited pay day.

Here’s the Rub

But (you knew that was coming, right?) here’s the rub. First, the Fed has gone out of its way to communicate to the markets that the FOMC has no intention of raising rates unexpectedly or in a rapid fashion. No, the “trajectory” or “glide path” as it is referred to by Fed Governors, is expected to be shallow, smooth, and steady.

Next, and this is the important part, the macro environment may not warrant an ongoing rate hike campaign and may actually keep Yellen & Co. on the sidelines after the initial “liftoff” occurs.

Here’s the thinking… The key is the fact that the U.S. will soon have a monetary policy that is divergent from the central banks of Europe, Japan, and China. In other words, the ECB, BOJ, and PBOC are all still easing rates while the U.S. is looking to hike rates.

The argument can be made that even before the Fed gets around to announcing their first itty bitty rate hike, the easing from the rest of the world represents a defacto tightening in the United States.

Why do you care, you ask? In short, because the divergent monetary policy causes the U.S. dollar to strengthen.

And what does a stronger dollar mean from a macro point of view? For starters, it means lower commodity prices, which, in turn, leads to a reduction in inflation expectations.

But wait, isn’t the Fed trying to get inflation to go up and not down? Haven’t the FOMC members been yammering on about inflation being below their 2% annual target for some time now?

And doesn’t it make sense that if the ECB, BOJ, and PBOC continue to boost their economic growth rates via further monetary easing that the greenback would continue to strengthen? (And are you seeing the potential loop here?)

The answer is yes. And coming full circle, the question then becomes, what exactly does all of the above mean for bond prices? Cutting to the chase, if foreign central bankers continue their “easy money” policies and stimulus programs due to lagging economic growth, it means that (a) the U.S. economy may be at risk too and (b) the Fed may not be able to raise rates as much or as quickly as they’d like to.

So, if your macro view includes slowing growth in places like Europe, Japan and China (which, it should in the near-term), how are interest rates supposed to surge in the U.S. again?

The Takeaway

The takeaway here is if the U.S. economy can simply ignore the economic malaise happening in some important places around the world, then, for sure, rates could rise here at home. But without a big batch of inflation or strong growth around the world, it would seem unlikely that rates would rise enough to create the mega bear in bonds that so many are looking for.

Next, from a shorter-term perspective, Eurozone bonds have been on their front foot recently due to (a) heightened expectations of more QE from the ECB and (b) a flight to safety in response to the terrorist attacks in Paris. The point is with rates falling in Europe, it makes the Fed’s rate hike plans a bit more complicated.

And then there is the issue of supply. Don’t look now but with central bankers buying everything in sight for many years now, the supply of bonds available in the market is – believe it or not – becoming a problem. And what happens when there is more demand than supply? Prices go up, of course. Or at the very least, bond prices aren’t likely to dive in this environment.

So, while the potential for bear market in bonds would seem to make some sense after a 30-year secular bull, the current macro picture may not support a quick death of the bond bull.

But then again, I could be wrong. Which is why we don’t invest money based on our macro view of the world!