NEW YORK (Reuters) - Three months ago, with the Federal Reserve nearing the end of its second major stimulus program and inflation pressures on the rise, Albert Edwards’ bond market view stood out from the crowd.
Societe Generale’s famously bearish analyst, in contrast to most, did not see 10-year Treasury yields rising above 3 percent just because the Fed was going to stop buying bonds. Instead, he predicted they would fall below 2 percent.
So far, Edwards — who predicted the Asian financial crisis of 1997-98, the U.S. housing implosion and who sees China’s economy suffering a hard landing — has been closer than most on his debt call. Last week, yields tested their record low of 2.04 percent.
Investors, however, should hope he’s not as accurate on his next call: Edwards sees Treasury yields falling further because, he says, the economy will weaken. He is targeting benchmark rates at around 1.50 percent in the next six months.
Be sure to lock in a low-rate mortgage while you can, though. After that, says Edwards, a period of hyper inflation will push bond yields into double digits and send the S&P 500 stock index tumbling to 400, only a third of its current value.
“On a 10-year view I think government bonds are a horrible investment,” Edwards told Reuters in an interview. “My view is that the end game for all this is monetization and trade war and very rapid inflation.”
London-based Edwards admits his views are outside the mainstream.
“Many think I am mad,” he wrote in a recent report.
Still, Treasury yields have fallen from 6.5 percent in 1996 when Edwards went overweight the debt.
And, with nerves shattered by wild price swings and portfolios that still show losses from the 2008 financial crisis, more people may be receptive to markedly bearish views.
Edwards says the economy is in an Ice Age — his term for a period of low inflation and near deflation and in which the economy has seen a broad deleveraging from the stock boom of the 1990s.
“That was the great moderation — the great moderation was a lie and a Ponzi scheme built on these massive debt mountains. And now those are finished you go back to normal, or worse than normal because you’re so vulnerable,” he said.
Deleveraging leaves the economy more vulnerable to tightening, more volatile and shortens the gap between recessions, he said.
In this way Edwards sees the U.S. economy playing out similarly to Japan’s, which has experienced two “lost decades” marked by stagnant growth and low interest rates.
“I think the U.S. is very much following the template of Japan,” he said. “There are key differences but there are massive, massive similarities.”
Edwards’ Ice Age is marked by a period when bond yields gradually decline as equity yields, as measured by averaging earnings and dividends, cheapen from the lows offered during the stock boom.
The next phase, however, will be rapid inflation that hurts bond and equity positions alike.
What will end the bond rally is hard to pinpoint. Most likely, he said, it will start in Japan.
“I think Japan will be the first to crack, really crack,” he said. “Its demographics mean that big pension funds can no longer fund its huge deficit out of internal savings.”
Even with extremely low interest rates — Japan’s 10-year notes yield little over 1 percent — the cost of servicing the country’s debt will suck up over 20 percent of its 2011 budget, according to Japan’s Ministry of Finance.
Any upward pressure on yields has the potential to cause large and broad damage that would be felt internationally.
“The markets can be quite forgiving for quite a while, but basically a country is deemed insolvent when the market for whatever reason decides it is,” said Edwards.
“You will get repeated rounds of money printing to try and stop it, but ultimately gravity has a habit of pulling markets down to where they should be. You can delay it, you can play around, but ultimately the pigeons come home to roost.”
Editing by Leslie Adler;