Liquidity in the bond market has dried up to levels not seen since 2008, according to Loomis Sayles vice chairman Dan Fuss. Though it is hardly a full-blown financial crisis like the one experienced in 2008 and 2009, Fuss believes it is almost inevitable that chaos in the bond market will spill over into the economy.
The big question is how far the fallout for general economy will extend and how long the paralysis is various sectors of the bond market will last. Fuss, who spent the last year and a half shortening the maturities of all the firm’s bond portfolios, acknowledged that’s not certain.
But he suspects that the fixed-income market will experience a series of secular corrections over the next decade with about 100 basis difference from one starting cycle point to the next. This is the first one and he thinks much of it could be behind us.
That view stands in stark contrast to Mike Temple, Pioneer Investments’ director of credit research, who thinks the yield on the 10-year Treasury could surge to 4.0% over the next 18 months. Temple said that with U.S. private sector improving the economy is reaching the point where it can achieve “escape velocity.” As evidence, he cites the boom in U.S. energy production and its future spillover effect into related industries, that have already lifted U.S. private sector GDP growth to 3% or higher in recent quarters.
The net effect is a “new paradigm’ for bonds, Temple noted. Consequently, one can expect continued volatility in global equities and debt markets, as various securities “oscillate wildly” while investors figure where the safer havens are and what new fair-value prices should be in a changing business environment.
Fuss thinks it is unlikely that the 10-year Treasury bond will reach 4.0% by January 2015 because the current mayhem in fixed-income markets will feed back into the real economy. “The key variable is housing,” he said, because it influences consumer psychology.
Home prices have been surging at nearly an unprecedented pace, with supply scarcity and pent-up demand combining to create an imbalance that prompted the National Association of Realtors, typically the industry’s loudest cheerleaders, to warn that conditions were frothy and unsustainable. Even though mortgage rates remain low, Fuss says that if rates keep rising the mortgage market could grind to a standstill.
“Liquidity for mortgages is as bad as it has been,” he declares.
Other bond markets aren’t much better. “The Treasury market is extraordinarily poor,” Fuss added. “Munis’ [liquidity] stinks, although they are becoming attractively priced, if you can find them.”
Higher interest rates ultimately will affect other consumer sectors via credit card rates and other increased costs. “I’m sure the big retailers are starting to get worried about this,” Fuss said.