Nuclear Bond Implosion Ahead

The US Fed's measure for long term inflationary expectations may keep it from dropping rates much further, potentially setting off a 'nuclear' bond-price implosion.

An only hours-old Bloomberg article details why "Chopper-Bernie" may have to ground his inflation-helicopter much earlier than anyone expects.

In essence, an inflation indicator used by the Fed, and literally signed off on by Alan Greenspan, indicates that bond investors' long-term inflationary expectations are on the rise - and significantly so.

Bond investors have recently been lulled into a false sense of security by the alleged 'fact' that inflation remained so low.

That sense of security is now flying out the window.

It's no secret that we at the Small Business Goldmine believe the Fed has been buying longer-term treasuries and thereby has manipulated what the public uses as its gauge of inflationary expectations. Whether that is so or not, if investors - especially those of the institutional kind - are now smelling inflation in the air, the Fed's buying efforts could be drowned out in a second and a half. The bond market is just that big.

Now, we all know that rising inflationary expectations limit the Fed in how low it can go with its funds rate, so one or the other thing will have to give.

What will have to give is either the Fed's laughable pretense of being an "inflation fighter" (right - like a fuel-tanker truck claiming to be a fire truck!) or it will lose its ability and willingness to lower the funds and discount rates.

Our guess is that we will see the Fed's inflation-fighter image go "poof" within the next few months, and that means we will all get our interest rate crack that we depend on so much - but at a far higher cost than anticipated.

The cost will be very palpable. It will come in the form of literally everything. Inflation, inflation, inflation - and that will mean bond traders and investors will sell, sell, sell.

Ironically, that will have the effect of raising long-term interest rates because bond prices move inversely to bond yields, and yields in turn determine long term rates like those on - mortgages.


It's ironic because it means that, the lower the Fed will drop its short term rates, the higher the longer term rates will go - and that will stop longer term lending in its tracks.

Note that when we say "longer term", we are talking two-year time frames or shorter here.

Nuclear fissions or fusions usually cause explosions rather than implosions, but what is coming will turn that erstwhile principle of physics on its head.

What is coming is a wholesale exit from US treasury bonds, the likes of which the world has not seen. Might as well call it 'nuclear.'

Since the whole financial world rides on debt, the level of which is inexorably connected to interest rates, any dramatic rise in rates will cause debt - and therefore money - to implode right alongside it.

There is only one financial asset that will stand clear from the mayhem and destruction this will engender.

Got gold?

Alex Wallenwein
Editor, Publisher
Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

December 10, 2007