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Friday, June 08, 2007 11:56 PM

The Bond King's Capitulation

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After yesterday's bond rout Bill Gross finally turned bearish on bonds.

PIMCO manager says strong economic growth worldwide should push up interest rates and yields.

Legendary bond investor Bill Gross expects strong economic growth worldwide to push up global interest rates and put a damper on the Treasury market.

A long time bond market bull, the PIMCO manager says he's now a "bear market manager" and has raised his forecast range for the benchmark 10-year U.S. yield to 4 percent to 6.5 percent. That's up from last year's forecast range of 4 percent to 5.5 percent.

Treasury prices have dived on inflation worries, global rate hikes and concerns of possible rate increases from the Federal Reserve. On Thursday, the 10-year yield rose above the key 5 percent level for the first time since August. Bond prices and yields move in opposite directions.

Gross said he expects global growth to advance at a strong pace of 4 percent to 5 percent over the next three to five years and for inflation to rise mildly in the United States and worldwide. That combination "is not necessarily bond-friendly," his comments said.

Besides inflation rising slightly higher, the bond market faces other pressures. Central banks and asset managers are likely to shift away from safe-haven investments, such as U.S. Treasurys, as they seek out higher yields, Gross said.

The appetite of foreign central banks for low-risk assets like U.S. Treasurys has been one of the reasons why yields on U.S. government bonds have remained low for so long. Gross said investors should take advantage of global growth.
Are any bond bulls left?

Gross turning bearish on bonds is an interesting event. Is there anyone now who is not a bond bear? I have to admit that the break in the long term trendline on the 30-year bond look ominous.

I discussed this yesterday on my blog in Gold Breaks Down In Treasury Rout
There was an absolute rout today in bonds, not just in the US but globally. Treasury trendlines are now clearly broken in several major countries. Following is a chart of the 30 year bond showing a distinct break in a trendline that dates all the way back to 1981.

click on chart for a much sharper image

Bonds were also hammered in Germany, Canada, Japan, and Spain. Does everyone believe this growth is causing inflation story? Now? Finally? I don't buy it.

Nonetheless, this all seems to all be a part of the "Good news is bad news story". On the first smattering of good news (see Good News Everywhere!) traders headed to the hills (in nearly everything).

Now that finally everyone senses that the US economy is in some sort of soft patch as opposed to the Fed being forced to cut rates because of the slaughter in housing, the stock market and bond markets were both clobbered by good news.

Subprime fallout is going to get worse

One thing's for sure and that is this rise in yields is very bad news for the housing sector. Everyone hoping for the Fed to rescue housing just had those hopes dashed. And here is a nice chart showing just what is coming up.

Now that Gross has tossed in the towel and foreign central banks everywhere want to diversify not only out of US dollars but also out of treasuries as well into higher yielding investments, it would be fitting if the US dollar puts in another sharp rally and the global growth story finally gets turned upside down.

The long term bull in bonds may be over but as of right now I am sticking with what I said yesterday: "The highs in bonds and the lows in yield have now likely been set. However that does not change my stance that once this unwind of leverage occurs, a recession sets in, and housing further collapses that the Fed will be cutting rates and yields will drop significantly. That is when I am looking for the next major rally in gold."

With the capitulation of Gross and the actions of foreign central banks there are just too many disbelievers in bonds now for my taste. A further collapse in housing and a slowdown in worldwide growth will eventually provide a test of conviction for the new bond bears as well as another huge whipsaw for the derivatives desk of Fannie Mae. Won't that be fun?

Mike Shedlock / Mish

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