Why Bonds Stay Strong Despite Years of Dire Predictions

For years now all we hear are predictions that bond yields will rise and those holding bonds will take a bath. The most compelling argument for a rise in bond yields, which conversely means a fall in bond prices, would have to be the observation that bonds have been in a bull market since roughly 1980, that bond bull markets last roughly 30 years, and that 2010 marked the 30th year of this bond bull market cycle. Almost four years having passed since 2010, we're still waiting for the collapse that had one analyst, whose research we receive, adamantly insist in 2011 that if treasury bond yields don't shoot up, he'd eat his hat. This immature comment was followed by no hat-eating to date, a video of which would have been the appropriate response if you're going to make such a bald statement. One would have respected this, but alas he didn't man up and so left himself flaccidly flapping in the breeze. Embarrassing, wouldn't you say?

In any case, while the lack of follow-through on the part of bonds to the overwhelming consensus ought not surprise us. It's usually the case that when "everyone" agrees that an item "must" either rise of fall, the opposite usually occurs, in this case the wisdom of the mob not being worth the hot air that accompanied the loud certainty of the proclamation of dire consequences certain to befall anyone foolish enough to hold long bonds (like, for example, us).

But in addition to taking a contrarian stand when faced with such one-sided trades - in this case going short bonds - we might find some explanation for the strength bonds continue to display despite being on the back end of their long-term bull market. And here we find that, similar to companies buying back their stock keeping stocks in elevated territory, banks have been gorging themselves on bonds. Such buying has gobbled up all the treasuries sloshing around as the Fed continually slops dollops of "liquidity" into the markets. This constitutes a sure and steady source of demand for available supply.

Banks’ holdings of U.S. government debt securities rose last month by the most since 2010, even as Treasuries slumped on deepening concern the Fed would end more than six years of near-zero rates sooner than some investors expected. The 0.6 percent decline was the biggest monthly loss of 2014.

Rather than lend, banks prefer turning their cash into government bonds. Of course, this can't last. Bonds will begin to fall, er, next year, it seems:

Faster growth next year will prod banks into shifting their cash away from government bonds to boost lending, which has taken six years to recover to pre-crisis levels, said Matthew Burnell, a senior banking analyst at Wells Fargo & Co.

Yeah, that's it. The recovering economy will spur companies to seek loans to grow their businesses. Banks will lend their cash to companies rather than buy treasuries. I get it.

“We expect the banks are going to see stronger loan growth, so more of their liquidity will be going into those types of earning assets,” Burnell said by telephone Oct. 3.

So there we have the latest reason why bond yields will rise and prices will fall. You can take that to the bank. Right?