“Smart Money” Prepares to Profit from Bond Market Rout

“If I had an easy way and a non-risk way of shorting a whole lot of 20- or 30-year bonds, I’d do it,” said our favorite uncle Warren Buffett on CNBC. These kinds of bonds have been on a terrific bull run ever since Paul Volker, as Chairman of the Fed, cracked down on inflation. But now, even the avuncular face of capitalism would bet against them.

He was behind the curve. On April 22, Bill Gross, at Janus Capital, tweeted that 10-year German government debt was “The short of a lifetime.” The “only question” was “Timing.” Other bond gurus have jumped into the fray. Selling bonds outright, or selling them short if you didn’t already own them, particularly European government bonds, has become the thing to do in certain circles. Now valuations are falling, and yields are soaring off their ludicrously low levels.

So within the last 30 days, the 10-year US Treasury yield jumped from 1.83% to 2.23% as I’m writing this; the German 10-year Bund yield, instead of dropping below zero, skyrocketed from 0.05% to 0.60%; the Italian 10-year yield soared from 1.18% to 1.93%. And so on. Sharply rising long-term yields are percolating through the system.

In the era when several trillion dollars of even crappy government debt is so overpriced that it sports negative yields, thanks to central-bank machinations, this bout of selling is somewhat inconvenient.

Bonds with long maturities are particularly vulnerable. That’s what Buffett, the ultimate “smart money,” would focus on. And selling them is exactly what companies are doing at a record pace while there are still eager buyers for them out there.

When Oracle sold a bunch of bonds, it included $1.25 billion in bonds due in 2055. That’s 40 years from now. In return, Oracle will pay a coupon of 4.375%. Investors are dying for this kind of yield. Microsoft sold $2.25 billion of 40-year bonds back in February with a coupon of 4%. For both of them, it was a first. Massachusetts Mutual Life Insurance issued 50-year bonds.

So far this year, according to Bloomberg, companies have sold $39 billion in bonds that mature in over 30 years. That’s over five times more than during the same period in 2014.

Companies have pushed out duration – though it costs them more to do, for now. But they’re locking in the cheap money for a generation. Maturities for bonds issued so far this year average 16.4 years. If it stays the same for the full year, it will be a record, and far above the average going back two decades of 10.7 years.

Companies have sold $627.2 billion in bonds so far this year, up 6.57% from last year at this time, which had already been a record year. For the full year 2014, total issuance hit a vertigo-inducing $1.57 trillion.

So, companies are borrowing a record amount to fund share buybacks, acquisitions, and other mouthwatering hocus-pocus goodies. They’re leveraging up their balance sheets with these records amounts of debt, and they’re venturing at a record pace into maturities that exceed the remaining lifespan of many bond-fund investors.

These companies, too, are the ultimate smart money. They’re doing what Buffett would like to do, and what the shorts are now doing, this being the deal of a “lifetime”: they’re selling bonds that mature so far in the future that redeeming them is going to be another generation’s problem.

Heck, governments do it too. Even Mexico, which has a solid history of foreign-currency debt crises, a month ago was able to sell €1.5 billion in 100-year bonds at a 4.2% yield to maturity.

But for the buyers, for the very folks who have been scrambling over each other to grab a piece of this reeking pie, for the yield-desperate bond-fund managers, insurance companies, and others that have been driven to near-insanity by years of interest-rate repression and QE, for all those eager buyers who’ll end up owning these bonds in their conservative-sounding bond funds, for them, these bonds might curdle.

Never before has “duration” – the sensitivity of bond prices to interest rate increases – been higher, according to Bank of America Merrill Lynch index data cited by Bloomberg. If interest rates rise from these artificially low levels, these investors are going to take a bath. Bond funds are going to get hit brutally.

And if there is a big bout of inflation at any one time during the next many years or decades – a lot of stuff happens in 30 or 40 years – that record amount of debt, issued during times of super-low interest rates, will become the scourge of those who own it.

“The environment is much riskier for investors,” Jim Kochan, chief fixed-income strategist at Wells Fargo Funds Management LLC, told Bloomberg. “At these low-yield levels, it doesn’t take a big move to lock in losses.”

Those who bought the Oracle and Microsoft 40-year bonds have already taken a hit when yields began to rise. Even small increases in yields have a big impact on 40-year bonds.

But for companies it may be the last chance to get their hands on ultra-cheap long-term money as the Fed’s cacophony is increasingly clear that rates will eventually rise, even if much of Wall Street is clamoring for ZIRP Infinity. For 40-year bonds, it doesn’t matter whether rates begin to rise in June or September; 40 years is a long, long time.

And bondholders carry all the known and unknown risks of those four decades in return for what is still a minuscule amount of yield. That’s why the ultimate smart money is selling them at a record pace to still eager bond-fund managers that will stuff them, and all the associated risks and potential losses, without compunction into retirement nest eggs. Thank you hallelujah central banks for this deal of a “lifetime.”

As if a toggle switch had been flipped late last year, Americans suddenly gained confidence in the economy, to levels not seen since before the Financial Crisis. But now, it’s all unraveling. And the culprits are being lined up. Read…  Confidence in the US Economy Plunges

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  14 comments for ““Smart Money” Prepares to Profit from Bond Market Rout

  1. Mike R. says:

    The Weimar Germany hyperinflation was great for people and companies that owed (not owned) debt. Their debt vanished as the currency collapsed and they gained valuable property and businesses essentially for free. Of course the vast middle class was wiped out: The “rentier class” that owned that debt that became worthless.

    Perhaps companies and others are hedging something similar might happen again. If not hyperinflation, significant inflation that wipes away most debt through currency devaluation.

    Of course we all know how that ended for Germany. Everyone may be careful what they wish for.

    • Vespa P200E says:

      Well be careful what one wishes for as currency devaluation “wars” often results in trade wars which in turn trigger real wars.

      And nasty outcome of the currency devaluation AKA print FIAT currencies result in inflation monster forcing the global CB cabals to increase interest rate and bringing about dreaded STAGFLATION.

      We indeed live in the interesting times and time to brush off dirt off the history books in the world who belives that debt prob can be solved by more debt or something…

  2. NY Geezer says:

    1.83% to 2.23% is likely just the first leg of this interest rate move. Since this move is fueled by the big smart money they probably have shared their target as that would be a way to assure that the move will be very profitable for them and nothing they do is ever prosecuted.

  3. Vespa P200E says:

    “So within the last 30 days, the 10-year US Treasury yield jumped from 1.83% to 2.23% as I’m writing this”

    ZIRP along with last QE III lasted too long (to reward the TBTF banksters and the governments of the world with heavy debt loads) and outlived its “usefulness”. Desperate to goose up “spending and lending” global CB cabals brought the NIRP along with more QEs especially outside US in EU, Japan, etc.

    Fed getting tad nervous trumpeted the rise of the rates (WTF?) in NIRP environment, global economies slipping back in the Great Recession and mighty strong USD. Guess Fed bogeyman is doing what is unpalatable for the Fed to do since the benchmark 10-yr yield is rising and taking along the “smart” money shorts like Buffett and bond king Gross who talks openly about shorting but busy unloading it to muppets of the world and retail investors hungry for yields.

    Alas the yield hungry investors will learn a harsh lesson that their bond will be worth less as the yield rises… Maybe the next down leg in the equity market will be triggered by possibly mother of all bond market swoon?

  4. sangell says:

    At the beginning 2014 the 10 year was pushing 3%. A year later it was
    under 1.7%. What the future holds 10 or 40 years hence is anyone’s guess but anything beyond a trivial rise in interest rates does not seem feasible for now with China, Japan, UK, UK and EU all choked with public and private debt. The Central Banks won’t permit it. If they can’t stop it the game is over. Where would the US Congress get the funds to service the debt if the cost were to rise from $300 billion to $600 billion plus per year and how long would the Euro stay together in a 4 or 5% world? Don’t even think about Japan?

    • Vespa P200E says:

      “Where would the US Congress get the funds to service the debt if the cost were to rise from $300 billion to $600 billion plus per year”

      Well I think the options are:

      1. Print more USD to service the higher rate with inflation as downside.
      2. Raise taxes but limit it to capital gain as the taxes across the board may not be palatable but you can bet that TBTF banksters will lobby for it (heck they may even demand lower CG tax rate to further fatten their bonuses).

      • sangell says:

        I’m no bond trader but if by ‘print’ you mean issue more debt you get into the same circular problem we are in on the ZIRP side. You have to sell the bonds and if the Central Bank ( remember they are supposed to be tightening monetary policy) isn’t buying that means you not only have to roll over existing debt but sell the new debt which means even higher yields. That will flow back through the economy into mortgage rates, credit card, student and car loans.

        Since we don’t have any signs of inflation currently and with the Fed having ended QE I’d say the Fed as well as the BOE and ECB is in no position to raise rates. They can’t even reach their 2% inflation targets. Yellen has got to be bluffing.

      • NY Geezer says:

        I believe this is just a trading move to enable the smart players to cash in on a short play. Whatever their target it will not have any staying power. If the government has to pay some additional interest as a result it will be for a very short time. It will not have much an effect on the budget.

        • Mike R. says:

          Astute conclusion. I agree. Interest rates are not going substantially higher. Period. Sure there will be lots of jaw boning; but at the end of the day, maybe .5% on the short end. That will likely tank the economy.

  5. prepalaw says:

    Bond investors – do not be sucker-punched by an up-tick in interest rates. We can never return to normalcy, like 3% money market rates. That will result in huge devaluation of Treasuries, posted as collateral for derivative transactions – necessitating the posting of additional collateral and the ultimate destruction of the shadow banking system. Too much debt has to be serviced with “new debt”. The only hope for the people who created this mess is much lower interest rates – like negative rates. There can be no change in the economic status quo before the election. The illusion of good times prevailing must be preserved.

    • Wolf Richter says:

      Don’t forget inflation as a “solution.” That’s the normal route: wipe out the value of assets on the quiet. Four or five years of high single-digit inflation preceded and followed by the “normal” range of 3-5% … problems solved, debt cut down to size, wealth destroyed, real wages made competitive with Mexico….

      • prepalaw says:

        Wolf,

        all the central banks have succeeded in doing is inflating the volume of credits. They have not created any inflation in wages. They have inflated the cost of necessities like healthcare. I remember how home prices in nice towns were going up 10% per year between 1977 and 1980. Back then, people were chasing houses. Today, homes are been held off the market because the “owners” would have to realize a loss on a sale.

        Everything economic today is an artifice – nothing is real – the law of supply and demand driving prices – the law financial gravity – interest rates – the law of bankruptcy permanently destroying value – banks will hold assets on their books forever and mark their values to whatever.

        Banks were supposed to serve industry and commerce. Today, everyone and everything serves the banks.

        Just wait until cash is forbidden and your electronic accounts are arbitrarily assessed fees and charges every month. Three weeks ago, Warren’s bank charged me $2.50 to deposit $2,500 cash rent. I closed the account.

        We live in a world where we just react to one financial artifice after another. There is a far bigger agenda in the works than we can imagine. Being prepared for the worst can not be wrong.

  6. Vespa P200E says:

    Conspiracy side of my head tells me that this is all orchestrated by the smart money dominated hedge funds to unload their bond holdings to the soon to be muppets AKA yield hungry investors fleeing ZIRP return on the savings and money market funds. I mean Buffet and Gross et al articulate shorting bonds yet sounds like selling in droves.

    Next up is the Fed with partner in crime Treasury to float more 10/30 yr bonds to “tame” the rate and you can bet that the “smart money” is ready to short the very turd they sold to the investor muppets.

    This is the Government Sachs’ muppet playbook,,,

  7. Julian the Apostate says:

    It was the bond funds in my 401k losing money that shifted my focus to financial matters. After all, bonds were supposed to be ‘safe’ and preserve principal. It was a contradiction so I researched it and adjusted my thinking. But I don’t think the Muppets will get it until it’s too late. I want to compliment all of you that took the time to help Cordelia out. That’s where the Long Porch excels over other sites. Back to work, time to play in traffic.

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