Bill Gross’s Bond Bear Market May Become Real Soon

Investment

Bill Gross, the legendary bond fund manager, warned in his January Investment Outlook that once the yield on the 10-year U.S. Treasury Note moves and stays higher than 2.60%, “a secular bear bond market has begun.” The yield on that benchmark bond was 2.582% as of 12:08 PM EST Thursday, a worrying signal for followers of Gross, now a bond fund manager at Janus Capital Group Inc.

Furthermore, expectations are growing that the Federal Reserve will approve an interest rate increase next week, according to Bloomberg. Meanwhile, one method of technical analysis cited in Bloomberg’s March 9 article predicts that the 10-year T-Note yield will surge to 3%, should it pass a resistance line at 2.64%.

Dangers of a Credit Implosion
With the global financial system as highly leveraged as it is today, “One mistake can set off a credit implosion,” Gross warns in his latest Investment Outlook, dated March 9. Using data from Economagic.com, he notes that there is now more credit (i.e., debt) relative to GDP in the global economy than at the beginning of the 2008 financial crisis. Just in the U.S., credit now is 350% of annual GDP and rising. The figure was about 380% before the crisis, but only about 270% back in the year 2000. In China, the ratio has more than doubled over the past decade, to 300%.

Rising interest rates inevitably result in increasing numbers of borrowers being unable to meet their obligations. In 2008, Gross continues, central banks worldwide were able to prevent a run on the system through a program of quantitative easing (QE) in which they purchased trillions of dollars worth of bonds. This process is reaching its limits as yields have been pushed near or even below zero, and thus central banks have less flexibility today should a new crisis arise, Gross says. (For more, see also: Bill Gross: QE is “Financial Methadone.”)

Other Bearish Warnings
Hedge fund manager William Fleckenstein believes that central bankers “have created a monumental duration-risk bubble” by “keeping rates too loose,” according to a January article in Bloomberg. All else equal, the interest rate sensitivity of a bond’s price tends to increase as the coupon rate decreases. The very low coupon rates on recently-issued bonds expose investors to large price hits from small absolute increases in market interest rates. Fleckenstein suspects that the 35-year bull run in the bond market actually ended last summer.

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Mike Harkins, CEO and co-founder of asset management firm Levy, Harkins & Co., told Bloomberg, “As a bond investor, you are now effectively taking equity-like risk but with no return.” Additionally, he said, “It’s going to be a disaster for bond markets. Inflation is coming, and valuations are crazy.”