When will the Great Bond Bull Market end?

The purpose of this comment is to suggest what things may look like when the Great Bull Market in bonds, which began in 1981 with 30-year U.S. Treasury bonds yielding 15.25 per cent, finally comes to its glorious end.

For starters, it is safe to say that the bull market in bonds will end reasonably close to the point in time that inflation (or deflation) bottoms. This is because we have determined that the only economic factor that correlates workably with interest rates, at least for long-term Treasury bonds, is core CPI inflation. The bond market, like politics, is an emotional issue and not well-liked in general by Wall Street because it has a negative correlation to the stock market most of the time. The economic environment that most favours the long end of the bond market tends to be low or no growth, and bonds have traditionally been an asset-allocation decision that is bearish on the stock market. As a result, fear-mongering often takes the place of thoughtful and objective analysis when it comes to fixed-income market commentary.

It always pays to look back at history. Before the inflation of the 1970s to early 1980s, periods of high inflation were primarily associated with war. Increased credit demands to finance a war effort, combined with the drop in productivity that goes along with blowing everything up, is an inflationary stew. Wars were typically followed by brief periods of deflation followed by stable prices until the next war. In the 1970s, several factors other than war led to the brief bouts of hyperinflation, and they are much debated. What is perhaps most important to recognize is that whether it is war, OPEC or rampaging baby boomers, history supports the notion that high inflation, at least at the core CPI level, tends to occur in brief bouts.

The credit collapse of the 1930s around the globe dramatically altered social norms related to consumption, speculation and saving. Those who were adults with families in the 1930s shunned debt and believed in “pay as you go” for the rest of their lives. The inflationary shock of the 1970s did the opposite. Rather than save, the baby boomers executed a failed strategy of speculating their way to a dignified retirement. Now the clock has run out and their behaviour is poised for a dramatic change. Once again, the rest of society will have to go along with the change in fashion. This type of behaviour from the developed world will exert enormous deflationary pressure, particularly on asset prices.

In addition, the enormous amount of debt- and entitlement-expansion that has occurred at the government level will be an enormous drain on economic growth as taxes are raised to service the debt and budgets are dramatically cut. For this reason, it is appropriate to consider the possibility that the next secular uptrend in inflation must await the rebuilding of the household and government balance sheets to levels that launched the last uptrend.

The outlook is not entirely dependent on the behaviour of the developed world’s consumers, however. If we are really trying to envision the next 20 years, the emerging market consumers (in places such as China and India) have extremely low debt levels and high savings rates. Changes in emerging market consumer behaviour should be, on balance, an inflationary pressure. The forces that most contributed to disinflation in the past 30 years were globalization and technological innovation that led to dramatic improvement in productivity. There is no reason to doubt that these forces will continue to be strongly positive in the future. What is important is to look ahead at what all these variables are likely to contribute to the forecast.

Putting it all together, it is reasonable to conclude that prices are most likely to be stable for a generation. By stable, I mean flat, and perhaps oscillating around plus or minus 2 per cent. Because we have most likely re-engaged the old recession or started a new one, we may be headed to as low as 3-per-cent deflation during this downturn, though a deflationary spiral seems overly pessimistic even for this “perma bear.”

And what about the end of the Great Bond Bull Market? It could come soon. You heard right. Long-term Treasury bond yields could reach a secular bottom in the next couple of years. And what will it look like? Well, rates will likely be much lower than anyone expects and, as is typical of most secular market peaks, the public will probably swear by them. For the public to love 2-per-cent long-dated Treasury Bonds, it will first have to believe in stable or modestly deflating core CPI as a long-term forecast.

David Rosenberg is chief economist and strategist for Gluskin Sheff + Associates Inc. and a guest columnist for Report on Business.