Rosenberg vs. Russell: bull or bear on long bonds?
I recently penned two bearish posts about the outlook for US Treasuries, namely US bonds – the end of a 30-year bull market and Government bonds – what’s up? Let’s now turn to two other analysts for additional perspectives on this very pertinent issue.
Firstly, David Rosenberg chief economist and strategist of Gluskin Aheff & Associates, remains bullish on bonds (and bearish on equities) and argues as follows: “People are allowed to have their opinions but not their own facts. While the bearish view on bonds is predicated on the supply outlook for Treasuries – deficits only have a 39% correlation with the direction of bond yields. Commodities have a 33% correlation. In fact, headline inflation has a 64% correlation.
“What does have the best correlations? Try monetary policy – the ‘carry’ – which has an 88% relationship. And core inflation – the one everyone laughs at for excluding food and energy (then again, oil only has a 25% correlation with bond yields) commands a 75% historical relationship. Here are the correlations:
• Fed policy 88%
• Core CPI inflation 75%
• CPI inflation 64%
• Core PPI inflation 58%
• PPI inflation 40%
• Budget deficits 39%
• CRB Index 33%
• Oil prices 25%
• ISM 12%
“Where is inflation going? Down. Fully 87% of the time in the past, going back more than five decades, U.S. core inflation was lower in the year after the recession ended. Not only that, but 75% of the time, core inflation was down two years after the recession ended. This is because even as the economy moves off the bottom, the output gap lingers and exerts downward pressure on inflation. The problem is that core inflation has hardly ever been as low as this cycle when the recession ostensibly ended last summer – when the YoY pace was 1.7% (and now down to 1.3%).
“On average, the core inflation rate is down 154 basis points in the first year of recovery and if that were to happen again it would mean it will go as low as 0.2% by mid–2009. But here is the real kicker – core inflation historically declines a further 63 basis points in the second year of the expansion, which would then put core inflation in never-never land of -0.4%. Now you can see why we are bullish on the bond market.”
But bond bears abound. One of them is long-timer Richard Russell (Dow Theory Letters) who said: “David Rosenberg is an excellent analyst. But his thesis that bonds are headed higher because of baby boomers’ desire for yield is a very risky and theoretical scenario. Personally, I prefer to follow the market, which means the charts. The chart below (from The Chart Store) tells an entirely different story I showed this chart just before the bond market cracked. Here we see a huge head-and-shoulders BOTTOM pattern with an upside breakout, which means interest rates are now heading higher. Please show this chart to Mr. Rosenberg.”
My viewpoint remains that we are on the verge of entering a secular bear market in bonds. Whether we see more ranging for a while longer is difficult to know, but I will not be a buyer at these levels.
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