David Stockman: We’re in the Mother of All Bond Bubbles

A couple of weeks ago, the yield on the 10-year Treasury fell below the yield on the 2-year for the first time in 12 years. This inversion of the yield sparked recession fears in the mainstream. But in an interview with Tom Woods on Contra Krugman, former Reagan administration Office of Budget Management Director  David Stockman said this is really a sign of a different problem. He said we’re actually in the mother of all bond bubbles.

Stockman said the mainstream is looking the yield curve inversion through the lens of conventional wisdom, but there is nothing conventional about the current financial situation.

History doesn’t count any longer because we have financial conditions resulting from massive intrusion by the central banks that no longer really discount economic reality …  but simply involve the massive speculation and distortions that are caused by the central banks’ ‘only’ $25 trillion of securities that they’ve bought over the last 10 or 15 years and thereby falsifying the price of almost everything.”

Stockman noted that there is now more than $15 trillion in negative-yielding debt globally. Germany’s entire yield curve is now below zero.

This is something totally new under the sun. It’s the bond market wreckage that has resulted from the massive central bank money-printing that we’ve seen ever since the crisis in 2008, but that’s really been going on for several decades now.”

Stockman said he doesn’t think the inverted yield curve necessarily means anything in terms of where the economy is going, but it does point to a great deal of danger.

To understand Stockman’s point, you have to look at the fundamental dynamics of the bond market. Bond yields have an inverse relationship with their price. When you have a negative yield, that means you’ve driven the price of the bond way above par. It indicates significant demand for that bond.

What we’re seeing is rampant speculation in the bond market. Investors are banking on continued bond-buying by central banks. They believe this will continue to push prices up and they’re speculating on the rising prices. It’s nothing but a massive bond market bubble.”

Stockman uses a 100-year Austrian bond as an example. When it was issued, the yield was 2%. Eventually, the bond was trading at nearly twice its face value and the yield was under 1%.

That is nothing but rampant, crazy speculation … So, this is what’s going on in the bond market. The biggest speculative blow-off in history as traders are piling into these long-term bonds believing that the central banks are going back into QE – quantitative easing – heavily again.”

When these speculative investors pile into these bonds, it drives up the price and drives down the yield. Stockman says the problem is it can’t last.

This is the mother of all bond bubbles, and when it reverses – because a lot of these bonds are being bought by speculators on REPO and extreme leverage – when this bubble reverses, it will have devastating effects on the $100 trillion bond market – corporate and government – in the world today.”

Now you might be wondering: why would anybody even buy a 30-year bond with a negative yield? Stockman explains. These investors don’t care about yield. They are chasing the rapid price increases we always see in a bubble. It’s not unlike all of the people who were investing in real estate before the 2008 crash.

Typically, bonds are considered safe, conservative investments. You buy a bond; you expect to get that money back when it comes to term and you collect a modest amount – your yield.

But what’s happening right now is bond prices are rising so rapidly and so substantially that the usual suspects – the speculators who chase all of these shooting stars and BOGO stocks in the equity market – are now in the bond market doing the same thing.”

Stockman called it another case of the “greater fool theory.”

I’ll buy that negatively-yielding 30 or 100-year bond. The price today is 150. It’s going to be 190 a couple of months down the road. If anything starts to go wrong, I’ll sell it to the next sucker and pocket my capital gain and move on to something else. That is the very definition of a speculative mania that’s nearing the blow-off stage.”

Stockman said that in the sovereign bond markets, 10 and 30-year bonds are being chased for price appreciation and the buyers on the margin don’t give a wit about what the yield is because they’re going for a 10% game in the next 30 days or so. He reiterated that a lot of these bonds are being bought with borrowed money – as much as 9-to-1 leverage.

This is what’s going on right now, and it won’t end well. We know that for sure.”