With rates going ever lower, look for the bond bears to say the end is nigh.
May 22, 2003: 8:50 AM EDT
By Justin Lahart, CNN/Money Senior Writer
NEW YORK (CNN/Money) - The U.S. Treasury market is beginning to look like Crazy Eddie: Rates are so low, it's practically giving money away.
Back when last year kicked off and the 10-year note was throwing off 5 percent, most people figured yields couldn't go much lower. Now that it's at 3.4 percent, they can't do much besides scratch their heads.
"The bond market has gone crazy," said Brad Ruderman, managing partner at the Beverly Hills-based hedge fund Ruderman Capital Partners. "It's unbelievable what's going on."
It's not that Ruderman doesn't understand the logic behind the move: The Federal Open Market Committee, at its meeting two weeks ago, signaled it was going to keep monetary policy easy for the foreseeable future, and so gave investors carte blanche to buy longer term debt without the fear of being caught unawares by rising rates.
But the magnitude of the move -- the 10-year yield has dropped half a percentage point since the Fed meeting -- suggests that something else is afoot. It looks to Ruderman like some big investors may have been caught badly offsides, having bet that yields couldn't go any lower. Now they are racing to cover, sending Treasury prices higher, and pushing yields to their lowest levels since the 1950s.
Such short-covering rallies, because they are based less on fundamentals than they are on big money having made a big mistake, tend to reverse rather quickly. Once the shorts are flushed out of the market, there are no natural buyers to sustain the move. Bond yields could easily reverse and head higher here. And that may even give succor to the bond bears, who will say that the bubble in U.S. Treasury prices has finally come to an end.
But investors should be careful before they listen to the naysayers. Since the bond rally began in 2000, there have been three sharp spikes down in yield followed by reversals that everybody thought were the end of the bond rally. They were wrong, and given what the Fed is doing, they could be wrong again. In a tough operating environment, it is hard to imagine that financial institutions, with their cost of money almost guaranteed to be nice and low, aren't going to keep on buying.
How bold can big investors get when the central bank gives them this kind of guarantee? Take a look at Japan, where the key overnight rate is set at 0.1 percent and the 10-year government bond yields 0.55 percent -- a yield difference of just 0.45 of a point. In contrast, the yield difference between the fed funds rate and the 10-year Treasury comes to 2.15 percentage points.
In fact, according to international fund manager and investment adviser Marc Faber, if there is an investment bubble in the world, it is the Japanese government bond market. Because most people have come to assume Japan's economy will remain in a catatonic state forever, few believe that Japanese bonds are going to reverse and send their yields markedly higher any time soon.
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