Bonds and Deflation
safehaven.com
Several powerful forces have combined to drive US bond prices higher over the past few years. Chief among these forces has been the large-scale buying of US bonds by the Bank of Japan as part of its attempts to weaken the Yen, but other significant influences include yield-spread trades by banks and speculators, strength in Japanese Government Bonds, 'flight to safety' buying, and fear of deflation. What we want to do today, though, is not spend time analysing WHY the bonds have been so strong because we've covered this topic at length in other commentaries over the past year. Instead, we are going to look at the EFFECTS that this bond strength has had, and continues to have, on other markets.
One of the most important effects of the on-going strength in bonds is psychological because regardless of the fact that much of the strength can be attributed to government intervention (aggressive buying of US bonds by the Japanese central bank and the Fed's implied promise to hold the official short-term rate at a very low level until the employment situation improves), many analysts won't believe that an inflation problem exists until after bond prices move considerably lower. In other words, the consensus view is that if the US really was facing a serious inflation threat then bond prices would be much lower (long-term interest rates would be much higher); and this is despite the mountain of evidence that the on-going bond price strength has nothing to do with inflation/deflation.
Now, the knock-on effect of very few people perceiving an inflation problem is that the problem is able to grow because nobody in power, least of all the governors of the Federal Reserve, is interested in trying to solve a problem that supposedly doesn't exist. That is, persistent strength in bond prices prevents any obstacles from being placed in the way of additional inflation because the bond price strength places a smoke screen in front of the underlying inflation problem. This, in turn, means that the prices of those things that benefit from a burgeoning inflation problem are able to move much higher than would otherwise be possible. So, the longer that bonds can remain firm the higher the prices of gold and commodities will eventually move. By the same token, there won't be any need for us to worry about commodities and gold experiencing anything other than routine bull-market corrections until bond prices move sharply lower. |
