Since the beginning of 2009, the U.S. 10-year yield has averaged around 2.6%.
Consequently, most investors feel that interest rates have nowhere to go but up. However, from 1930 to 1955, the U.S. 10-year yield also averaged 2.6%. That's 25 years! There was even a double-digit annual inflation rate after World War II, yet rates stayed low.
Most people fail to realize that interest rate cycles can last a very long time.
Furthermore, the forces conspiring to keep a lid on growth and inflation – and hence interest rates – are secular (long-term) dynamics. We're in the latter stages of a historic global debt supercycle. Many developed economies are faced with aging populations and a contraction in their labor forces. Plus, technological advancement is producing a good type of deflation as well as contributing to a growing glut of low-skilled labor, thereby pressuring wages.
These factors aren't going away any time soon, which is why I don't believe our biggest risk is a meaningful jump in interest rates. However, a bond market upheaval does appear to be upon us, even if the risks are ignored in the financial media because the facts don't fit the “Treasuries are in a bubble so buy stocks” narrative.
The bond market revolt is in credit. High-yield energy bonds are going “bidless” with increasing frequency. Linn Energy's (LINE) 8.625% coupon bonds due 2020 have plunged from $90 in June to $60.50 as of this writing. Astoundingly, these bonds traded at par ($100) at the beginning of November 2014, when I warned about energy sector leverage.
SandRidge Energy's (SD) 8.75% coupon bonds due 2020, which were just issued on May 28, 2015 at par, have already declined to $74. This is an ugly consequence of the “reach for yield” phenomenon.
The bonds of basic materials producers are getting clubbed in similar fashion. AK Steel's (AKS) 7.625% coupon bonds due 2020 have declined from more than $90 to $60 in a little over a month.
