Why Greenspan Is Wrong About Bonds

By Lisa Abramowicz  Nov 8, 2016


The longest-dated U.S. government bonds have fallen out of favor in recent weeks.

The debt just posted its biggest monthly loss in more than a year, with one Canadian company selling 90 percent of its longer-maturity Treasuries ahead of the U.S. presidential election. And on Monday, former Federal Reserve Chairman Alan Greenspan predicted that the bonds are poised for a significant selloff, with yields potentially doubling to historic levels of up to 5 percent.

Going Down
Long-term U.S. bond yields have dropped in recent years amid unprecedented central-bank stimulus
Greenspan is a polarizing figure who runs an advisory company. Some argue that his policies at the Fed sowed the seeds for the worst financial crisis since the Depression. But Greenspan isn’t alone in his opinion about rising long-term yields. While Wall Street analysts have ratcheted back their expectations for higher rates in recent years, they generally think that benchmark rates will rise over the coming year.
Looking Up
Analysts surveyed by Bloomberg expect 30-year bond yields to creep upward in the next few years
The data is based on the weighted-average forecasts of analysts surveyed by Bloomberg

The main argument is inflation. If consumer prices rise, investors will be less willing to accept such low returns to lend to the U.S. government. And the market certainly seems to think inflation is picking up a bit. You can see this looking at the big flows into inflation-protected bond funds and trading in derivatives contracts.

Inflation Expectations
Traders are pricing in a somewhat higher long-term inflation rate now relative to earlier this year
But even if consumer prices continue to rise, the likelier direction of longer-term rates is still probably down, leading to further gains on U.S. government bonds. That’s the view of Van Hoisington, a Texas-based money manager who has called Treasuries right for the past few decades. Hoisington, who runs the $430 million Wasatch-Hoisington U.S. Treasury Fund, thinks that 30-year U.S. government bonds will post another rally, with yields on the notes dropping below 2 percent.

“We still believe the overall trend is toward lower interest rates,” said Hoisington, whose fund has returned an average 8.1 percent a year since its inception in 1986 and performed better than 99 percent of its peers over the past three years. “We continue to hold our long position.”

Even if inflation does pick up, it’s more likely to just eat into consumer budgets, preventing them from spending as much and adding to an economic slowdown, he added.

Jim Bianco of Bianco Research in Chicago has a similar view, saying last week that the next move in benchmark borrowing costs will probably be lower, not higher.

Regardless of the outcome of the election, it’s unclear what the government will be able to do to ignite more growth in the near term. When the smoke clears, investors will be faced with the same economic backdrop of slowing growth, an aging population and some big debts to pay. It’s difficult to see how this will lead to runaway inflation in the near term. It’s easier to see the path to low long-term rates for some time to come.



Nuria Pujol