The Fed’s unprecedented levels of stimulus have indeed inflated risk assets and perturbed the natural equilibrium in a number of markets.
Treasury bonds are no exception. In fact, the bubble in U.S. government bonds is long in the tooth and now starting to show cracks.
10-year Treasury bond futures lost 7% in a few short months as the financial media became obsessed with the possibility that the Fed would ease off the gas, reducing its monthly allotment for bond purchases.
Here’s the short-term chart of 10-year Treasurys that I shared with you recently, as a bearish head-and-shoulders pattern was forming.
Sure enough, bond prices continue to fall after making a bearish break below the neckline of this pattern (which you can see by the light blue line I’ve drawn onto the chart).
As the break occurred alongside the Fed’s announcement that it will indeed taper its purchases — to $75 billion a month, from $85 billion — it’s safe to say that the taper is bad for government bonds.
The thing is, bonds have a lot further to fall when you consider the longer-term view. Here’s a chart of 10-year Treasury futures going back to 2001.
After moving sideways between 2003 and 2006 (white lines), bond prices broke into a strong uptrend beginning in 2007.
Now that bonds have fallen from favor, prices could retrace more than half of the bull market since 2007. That puts bondholders at risk of a 22% drop from current prices, or 26% from the May 2013 peak (marked “Taper Talk” in the chart above).
Time will tell if the bond bulls will brush off the Fed’s taper in 2014.
For now, early signs suggest the bull run in government bonds is quickly coming to an end. Either way, watch for the bond bubble to be a hot topic in 2014.
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