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The Bond Market Bubble Is Going to Pop Tomorrow

By Jeff Clark
Tuesday, July 17, 2012

No matter what Federal Reserve Chairman Ben Bernanke says to Congress this week, he's likely to burst the bond bubble.
Treasury bond prices have rallied dramatically over the past few months, and the yield on the 10-year Treasury note dropped to a historic low below 1.5% last week.
Most of television's talking heads argue investors are rushing into the perceived safety of U.S. Treasury obligations in one giant "risk-off" trade. "Investors are scared," they argue. "So they're willing to accept miniscule returns in exchange for keeping their principal safe."
I don't see it that way. In fact, the rush into Treasury bonds looks to me like the biggest "risk-on" trade we've seen since the dot-com stock mania...
You see, bond investors are playing a game of "front-running" the Fed. They expect another quantitative easing announcement – perhaps during Bernanke's testimony to Congress this week. They're counting on that announcement to push bond prices even higher.
No matter what happens, though, bond traders are going to be disappointed.
The tremendous rush into Treasury bonds over the past few months has set up a near-perfect "sell on the news" environment. If we don't get another QE announcement, the bond market will sell off on the disappointment. If we do get a QE announcement, the bond market has already discounted that news, and traders are likely to sell on the event.
Think about this...
In November 2008, as Lehman Brothers was going bankrupt, the mortgage market was disintegrating, and the financial world was on the brink of collapse, the Federal Reserve Board made the unprecedented announcement that it would use its money-printing abilities to prop up the price of Treasury bonds and mortgage-backed securities through what it called quantitative easing (aka QE) .
Bond prices rocketed higher and interest rates plummeted as investors realized the Fed would provide a backstop against any adverse move in the bond market. This was the first time the Fed had ever done such a thing. The market was not expecting the move, so it had not discounted that possibility.
Since then, the market has done an admirable job of discounting the Fed's willingness to manipulate bond prices. In March 2009, when the Fed announced an increase in the size of its QE program, Treasury bonds actually sold off on the news. Investors were expecting the action and had bought positions in advance of the event. So it was time to "sell on the news." Bond prices fell 15% over the next two months... and stayed down until June 2010, when the Fed hinted at the possibility of a second QE program.
Once again, investors rushed into the bond market – secure in the knowledge the Fed would prop up prices. Bond prices rose and interest rates fell as the market discounted the future QE2.
By the time the Fed announced QE2 in November 2010, it was time once again to "sell on the news." Bond prices fell 15% over the next four months.
Ever since QE2 ended last July, investors have been betting on QE3. It has to happen. The Fed has to keep up the charade. So folks have been piling into the bond market at record-high prices and record-low rates because they're discounting QE3.
If we do get a QE announcement this week, we'll likely have another "sell on the news" event.
It seems that no matter what happens with the Fed, this week should mark at least a short-term top in the bond market – if not a complete bursting of the bond bubble.
Best regards and good trading,
Jeff Clark

Further Reading:

In May, Jeff told readers to prepare for a third round of money printing. Last month, he explained what that would mean for the rest of the stock market... and offered a trade to make in anticipation of the QE3 announcement.

In The Daily Crux
Market Notes
Health care stocks are in an uptrend... Merck, Johnson & Johnson, and Eli Lilly hit new 52-week highs.
Betting on Warren Buffett pays off... shares of Berkshire Hathaway touch a fresh 52-week high.
Treasury bonds have skyrocketed... bond fund TLT is up 40% over the last 12 months, while the S&P is up 3%.
Constellation Brands nears an all-time high... shares of the World Dominating beverage maker are up nearly 50% in the past two weeks.
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