Why Bond Yields Won't Rise

Bond yields have to rise according to common wisdom bandied about these days. Since a rising yield means the price a bond goes down, everyone - and I mean EVERYONE - says you're crazy to hold bonds, particularly government bonds, most particularly long-term government bonds. The reason you especially don't want to hold long-term bonds is that, if yields rise, their prices stand to go down the most.

Well, maybe not EVERYONE thinks this.

For example, a few years back, following the logic of the day, I shorted the long bond and kept the short on for months. Didn't make much money, so I took off the short. Then I did it again. This time I lost a little. Meanwhile all the smart people I read were insisting that you should be short the long bond, no, MUST, be short the long bond. You just have to make money if you are.

Remember, this was back when only a few folks were touting shorting the long bond. Long story short, I took the trade off after that little loss and haven't bothered with it since.

But the "short the long bond" trade has, if anything, since gained in popularity. Indeed, one of the analysts whose research I pay for was so adamant at the end of 2011 the long bond would tank in 2012, he said he's "eat his hat" (and insisted he meant it) if it didn't. Well, it didn't and I'm still waiting for the hat-eating. (In fairness, I really didn't check in on him to see if he did in fact eat his hat; I really don't care either way. What I did learn was that he, like many of us, can lose his bearings from time to time and make intemperate comments. So what's new?)

So when I came across these remarks in Caroline Baum's recent Bloomberg Commentary, it caught my eye. (As I've mentioned in the past, Baum is one of the better financial journalists out there, so I like to check in with her from time to time.) She's referring to professor of economics Scott Sumner who she notes:

...views the Fed’s willingness to keep interest rates at zero for such an extended period as “a backdoor way of nominal GDP level targeting. The Fed would like a catch-up in growth before it starts tightening.”

She goes on to point out that

Sumner gave me more to think about. He believes that slow nominal and real growth accompanied by ultra-low interest rates are less a temporary phenomenon than the norm in developed nations with aging populations...What that means is 3 percent 30-year Treasury bonds are the “new normal,” a phrase I try to avoid. Normal implies that low yields are less a function of the Fed’s long-term asset purchases than investors’ expectations of low nominal GDP, Sumner said.

So in this guy's view, it's not only (or maybe not at all?) the Fed's QE program of purchasing bonds that's keeping interest rates low, it's a dramatic social change - the aging of the population - that's not only keeping them low now, but keep them low for a long, long time.

The guy's got a point about the profound impact of an aging population, as well as his comment that growth may simply be slowing down permanently in the West because of it. As for whether the yield on the 10-year and 30-year bond bond stays low forever - or something close to forever, I'm not so sure. Of course, I'm not EVERYONE, so what do I know?

Then again, if he's right, it means that maybe EVERYONE isn't right about the long bond being the absolutely, obviously, any-idiot-can-see absolute worst investment to hold in your portfolio.

On the other hand, if and when EVERYONE comes around to this guy's point of view, I might consider shorting the long bond again.