Reports of the Bond Bull Market's Death Are Greatly Exaggerated

 | Jan 11, 2017 | 3:00 PM EST
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Bill Gross and Jeffrey Gundlach, the two most widely followed fixed-income investors, have recently again weighed in on the end of the bond bull market. 

This time, Gross has targeted the 10-year U.S. Treasury yield breaking 2.6% as the signal that the secular end of the bond bull market has arrived, while Gundlach believes that threshold is 3%. 

As has become the norm over the past few years, whenever these two opine on the end of the bond bull market, I receive many inquiries concerning my response and whether I agree or disagree; I'll address those issues in this column. 

First, for both Gross and Gundlach, the new thresholds presented represent hedging of opinions they offered last summer, which were more definitive in their beliefs that the bond bull market ended with the Brexit vote and was evidenced in the rise in Treasury yields that followed it. 

Both proclaimed the record-low 10-year Treasury yield of 1.35% in July as the permanent low. 

A part of the rationale for the secular bond bull market to have ended was the imminent fiscal stimulus measures being promoted by both Hillary Clinton and Donald Trump as part of their fiscal measures. 

The fiscal stimulus was expected to come in the form of increased government spending, especially on infrastructure, which would drive economic activity, inflation and cause the Fed to raise the rate of increase in the fed funds target rate. 

If Clinton had won the election and the Senate had switched to Democratic control, as was believed at the time to be probable, that course of action would have been more likely than is the case under a Trump administration and a Republican-controlled Congress. 

The fiscal conservatives will not allow the increase in federal spending necessary to directly stimulate economic activity and the Trump domestic fiscal agenda will therefore have to be focused on providing the opportunity for the private sector to drive economic activity. 

That opportunity comes in the form of a carrot and stick. 

The carrot side is predicated in tax cuts and deregulation. The stick side is the threat of punitive measures being taken against U.S. companies for producing goods overseas with the intention of exporting them to the U.S. 

There is plenty of legitimate reasoning for doing both, regardless of the immediate economic circumstances. Neither, however, as I've written about repeatedly, will cause an increase in consumer demand. 

Put succinctly, nobody is going to go out and buy a house because their employer got a tax break. 

Further, the personal income tax reductions being promoted by the Trump administration are skewed to the wealthy. 

Just as is the case with the corporate tax breaks, though, nobody is going to go out and buy a house because the CEO of their company got a tax break. 

More importantly from the perspective of trickle-down economics is that consumption by the wealthy will also not be catalyzed to increase by personal income tax breaks because their income or net wealth hasn't been constrained. 

The financial benefits they've received over the past eight years from record-low debt costs and the resulting increase in asset values have had a far greater positive impact on their personal finances than the negative impact of the current personal income tax rates. 

It is far more logical that both companies and wealthier individuals will accept the tax breaks offered and continue to recirculate the benefits of them within the top of the economy. 

Companies will pass the tax savings on to their shareholders in the form of dividend increases, share buybacks and increased M&A activity, and those shareholders will pass it back to the companies in the form of increased share purchases. 

This will be beneficial for the companies, their shareholders and the financial economy, but will have little impact on the real economy. 

The providing of financial and economic potential through these kinds of fiscal measures will have the same impact on the real economy that the Fed's low interest rates have had for the past eight years. 

That does not mean these measures should not be taken. They should. 

But when offered alone and without a catalyst for the opportunity of consumption to be increased by income earners below the top 10%, or through the implementation of direct fiscal stimulus provided by an increase in government spending, they cannot provide the economic impact that the Fed, Gundlach and Gross are expecting. 

As economic activity begins to exhibit the reality of this situation, especially if the Fed continues to raise rates in anticipation of an increase in economic activity that does not materialize, I think bond market participants will send yields back down, and eventually below the record levels of this past summer. 

The secular bond bull market is still in place.

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