Bond bear has resumed

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I argued in two recent posts, US bonds – the end of a 30-year bull market and Government bonds – what’s up?, that government bond yields have embarked on a primary upward path (of course as long as the economy doesn’t double dip).

The paragraphs below from BCA Research concur with my viewpoint and are published without further comment.

“Cyclical ‘fair value’ for government bond yields is conceptually equivalent to long-run nominal GDP and is not much higher than current levels. However, there are a couple of structural forces that when added together suggest that there will be significant upward pressure on government bond yields in the coming years.

“For one, the credit crisis along with the unprecedented explosion in central bank balance sheets and budget deficits has increased uncertainty related to the outlook for inflation, growth and the exit strategy. In turn, the term premium has already increased from a low of about 50 basis points in recent years to around 100 basis points. We expect the premium to shift back into the range that existed in the mid-1990s, adding roughly another 50 basis points to equilibrium yields.

“Similarly, rising government bond issuance will gradually put upward pressure on bond yields as private sector credit demand revives and competes with the government sector for domestic savings. Already, there is early evidence that nonfinancial corporate borrowing has bottomed in the US The crowding out effect on interest rates could be 125 basis points or greater for the Treasury market.

“Bottom line: The longer-term equilibrium level of US Treasury yields is likely between 5.5% and 6%. Any backup in yields is likely to be led by the commodity-plays as well as the more cyclical US and U.K. markets. In contrast, euro area and Japanese bonds are likely to lag, along with monetary policy in these regions. We recommend staying overweight global spread product.”

Source: BCA Research, April 1, 2010.

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