U.S. Bond Market Facing a Lot of Headwinds
It’s very critical for investors to watch the U.S. bond market. It can’t be stressed enough; the bond market could be the thing that sends a wave of uncertainty across the board and causes panic selling.
You see, over the last 30 years, the U.S. bond market has been in a bull market. Why? Because interest rates were going down and inflation was relatively under control over these years. Both of these factors are great for bonds.
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This bull run in the U.S. bond market is being questioned. It could be over soon.
Why? We are seeing the complete opposite of what we had before. Inflation is starting to become a problem and the Federal Reserve is raising rates.
Just to give you some perspective on inflation, consider that between August 2017 and January 2018, in six months, inflation in the U.S. economy has increased to two percent. (Source: “CPI-All Urban Consumers,” Bureau of Labor Statistics, accessed February 20, 2018.)
Keep in mind, the Federal Reserve aims to keep inflation in the U.S. economy between two percent and three percent for the entire year. We have reached the Fed’s target inflation rate in just half a year.
What will the Federal Reserve do?
Since December 2015, the Federal Reserve has been raising rates. This is not news to anyone. But with inflation figures spiking higher, it will not be shocking if we see the Fed taking more aggressive steps and raising rates faster.
Bond Investors Getting Spooked
All of this is not good for the U.S. bond market.
And we see investors getting spooked already.
Please look at the chart below. It shows yields on the 30-year U.S. Treasury. Remember, if yields rise, it means bond prices are declining.
Chart courtesy of StockCharts.com
On the chart, there’s one thing worth noting; the long-term downtrend is breaking (look at the circled area). This says the U.S. bond market is facing severe headwinds.
This Could Be Bad for Stocks…
Dear reader, the U.S. bond market is a $39.0-trillion time bomb (that’s how many outstanding bonds there are in the U.S.). It has to be questioned, what happens as the Federal Reserve tries to tame inflation?
With all that said, there’s one prevailing theory these days and it suggests that, as the bond market sees a sell-off, investors could be rushing to buy stocks. So, investors could do well just by holding stocks.
I am thinking differently.
I believe that, as the bond market sees a sell-off, there could be a severe sell-off in other assets as well. This includes stocks.
My reasoning is very simple; relative to the historical average, stocks are excessively expensive. So a sell-off in the bond market could make stock investors question their future returns all of a sudden. Even if they sell just to take some profits off the table, we could have a massive sell-off at hand.
If you are not watching the bond market, you could be making a big mistake.
