CNBC Writes: Pimco: 3 reasons bond investors should chill

 

Bond investors are sweating bullets. In 3½ months, the 10-year yield has risen from about 1.6 percent to over 2.9 percent, before cooling off in recent days. And on Thursday, bond expert Jeffrey Gundlach made the case that the 10-year yield could reach 3.1 percent by end of the year.

As yields rise, bond prices fall, so the move in yields has been very painful for those who have owned bonds, and investors are heading for the exits. Bond funds saw outflows of $36.5 billion in the first 22 days of August, according to TrimTabs. Bond giant Pimco saw $7.4 billion worth of outflows in July alone, and double that in June.

But Tony Crecenzi, Pimco executive vice president, market strategist and portfolio manager, believes that the bearishness has gotten overdone. On CNBC’s “Futures Now” on Thursday, he made the case that “yields will move lower from here,” and he provided three reasons why.

1: Economic fundamentals don’t support these yields

Crescenzi said that yields could rise a bit more due to technical reasons, but the fundamentals don’t support it.

After all, “what’s priced into the bond market is the idea that the economy, in 2014, will accelerate,” Crescenzi said.

But he throws cold water on the rosy economic picture that some are drawing. “Bond investors will begin to reassess whether or not the optimistic forecasts, including the Fed’s own forecast, will come true.”

Indeed, many have questioned the accuracy of the Federal Reserve’s forecast for 3 to 3.5 percent GDP growth in 2014. On Tuesday, Krishna Memani, OppenheimerFunds’ chief investment officer of fixed income, said on “Futures Now”: “The economic growth that we’re looking for in the Fed’s forecasts is probably a bit overstated,” and for that reason, he, too, sees rates dropping.

2: Inflation is not coming back

While Gundlach compared the recent rise in rates to the rate rally in 1994, Crescenzi said the present situation is markedly different.

“What 1994 was about was the last big battle against inflation expectations,” Crescenzi said. “When the economy began to accelerate from the 1991 recession, people started to say, ‘Well hey, more growth means more inflation. Why can’t the inflation rate get back to 4 and 6 percent again?’ Then Alan Greenspan came in and stomped on the bond market with big rate hikes to say there isn’t going to be an inflation acceleration like there used to be in the ’70s and ’80s.”

Because “that inflation battle has been fought,” the Fed doesn’t need to hike rates in order to tamp down the rate of economic growth and thus reduce inflation, according to Crescenzi. That means that a full repeat of the 1994 bond catastrophe-in which yields rose nearly 2 percentage points in three months-is unlikely.

3: Investors are misreading the Fed

Crecenzi believes there’s an “80 percent chance” that the Fed will begin to taper its qualitative easing program in September. But he thinks investors are misreading when the Fed will raise their Federal funds rate.

Again, because the Fed doesn’t need to worry about inflation expectations getting out of hand, Fed Chairman Ben Bernanke has no need to hike short-term rates as Greenspan did. “Unlike 1994, there won’t be rate hikes to reinforce the rise in interest rates,” Crescenzi said. So according to Crescenzi, “there won’t be a rate hike until 2015 and the earliest, and we think 2016.”

Any rise in rates would be investor-directed, then-and since the economy will not be as good as investors expect, he does not expect to see rates get pushed higher.

In fact, by the end of the year, this bond guru sees rates falling back to the low to mid 2s on the 10-year.

The points outlined in the article above are important and must be addressed. As I have mentioned in my previous article  “The Most Important Financial Story No One Is Talking About”  interest rates on a 10 Year T-Note have increased 100% over the last 12 months. That is a huge move. Should the investors be worried? I think so. Let’s take a look and take away their argument.

1. Economic fundamentals don’t support these yields: Oh yes they do. I don’t think the market is pricing in growth, I think the market is pricing in upcoming defaults and beginning of an inflationary environment.

2. Inflation is not coming back: That is kind of a definitive statement. My work is showing that inflation is just around the corner and will start to accelerate in 2016. I think the bond market is starting to price that in as well.

3. Investors are misreading the Fed: This is not about the Fed. This is simply following the market and trying to determine what the future holds. The Fed has an imaginary control, not a real one.

The bottom line is this. As I have indicated in my previous post I believe the interest rates have bottomed in July of 2012 and are now starting their multi decade climb higher. Yes, the rates are likely to decline here (pull back) only to resume their climb upwards within a short period of time. Of course, this will have huge negative consequences on the overall economy, the stock market and real estate.  

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