Since last November, the U.S. Federal Reserve has been buying
U.S. Treasury bonds at a rate of about $75 billion a month. That's
part of Fed Chairman Ben S. Bernanke's "QE2" program, under which
the central bank was to buy $600 billion of the government
But QE2 ended Thursday, meaning the Fed will no longer be a big
buyer of Treasury bonds. So starting today, the U.S. Treasury needs
to sell twice as many Treasury bonds to end investors as it had
The problem is, who's going to buy them? Not China, which is
diversifying its trillions in assets to get as far away from the
U.S. dollar as fast as it can. Not Japan, which is trying to
rebound from its March 11 earthquake, tsunami and nuclear disaster
-- and is focusing all its spending on reconstruction. And, as
we've seen, neither is the Bernanke-led Fed.
I'm telling you right now: We are headed for an epic bond market
crash. If you don't know about it, or don't care, you could get
clobbered. But if you do know, and are willing to take steps now,
you can easily protect yourself and even turn a nice profit in the
A Timetable for the Coming Crash
I'm an old bond-market hand -- my experience dates back to my
days at the British merchant bank Hill Samuel in the 1970s -- so I
see all the signs of what's to come. Having the two biggest
external customers of U.S. debt largely out of the market is a huge
Unfortunately, those aren't the only challenges the market
faces. The challenges just get bigger from there, which is why I'm
predicting a bond market crash.
Steadily rising inflation is one of the challenges. Inflation is
a huge threat to the bond markets, and is almost certain to create
a whipping turbulence that will ultimately infect the stocks
markets, too. Many pundits will tell you that if investor demand
for bonds declines, and investor fear of inflation increases,
bond-market yields could increase in an orderly fashion.
But I can tell you that the bond markets don't work like that.
Price declines affect existing bonds as well as new ones, so the
value of every investor's bond holdings declines. And with many of
those investors heavily leveraged -- especially at the major
international banks -- the sight of year-end bonuses disappearing
down the Swanee River as bonds are "marked to market" will cause a
panic. That's especially true when end-of-quarter or end-of-year
reporting periods loom.
That's why we can expect a bond market crash at some point. If
you ask me to make a prediction, I'd say that September or December
were the most likely months for such a crash.
A Boxed-In Bernanke
One sad -- even scary -- fact about what I'm predicting is that
Fed Chairman Bernanke won't be able to do much about it ... though
he'll certain try.
Consumer price inflation is now running at 3.6% year-on-year
while producer price inflation is running at 7.2%. In that kind of
environment, a 10-year Treasury bond yielding 3% is no longer
economically attractive. Since monetary conditions worldwide remain
very loose, inflation in the U.S. and worldwide will trend up, not
down. At some point, the "value proposition" offered to Treasury
bond investors will become impossibly unattractive. When that
happens, expect a rush to the exits.
If Bernanke attempts "
" -- a third round of "quantitative easing" -- he will have a
problem. If other investors head for the exits, Bernanke may find
that the U.S. central bank is as jammed up as the European Central
Bank currently is with Greek debt: Both will end up as the suckers
that are taking all the rubbish off of everyone else's books.
There's a limit to how much Treasury paper even Bernanke thinks
he can buy. And if everyone else is selling, that "limit" won't be
high enough to save the bond market. With Bernanke buying at a
rapid rate, the inflationary forces will be even stronger, so every
Bureau of Labor Statistics report on monthly price indices will be
marked by a massive swoon in the Treasury bond market.
Eventually, there has to be a new head of the Fed -- a Paul A.
Volcker 2.0 who is truly committed to conquering inflation. It
won't be Volcker himself, since at 84, he is probably too old. But
it might be John B. Taylor
the "Taylor Rule" for Fed policy. The Taylor Rule is actually a
pretty soggy guide on running a monetary system. But it has been
flashing bright red signals about the current Fed's monetary policy
However, since a Fed chairman who is actually serious about
fighting inflation would be a huge burden for President Obama to
bear -- and could badly hamper his chances for re-election, any
such appointment is unlikely before November 2012.
How to Profit From the Bond Market Crash
Given that reality, it's likely that Bernanke will attack any
bond market crash that occurs ahead of the presidential election
just by printing more money; there won't be any serious attempt to
rectify the fundamental problem, meaning inflation will continue to
For you as an investor, this insight leads to two conclusions
that you can put to work to your advantage. The scenario I've
outlined for you will be very good for gold and other hard assets,
and challenging for Treasury bonds; prices will remain weak no
matter how vigorously Bernanke attempts to support them.
So what should you do with this knowledge? I have three
recommendations. First and foremost, if Bernanke were not around, I
would expect gold prices to fall following a bond market crash. But
since he's still at the helm at the Fed, I expect him to do "QE3"
in the event of a crash. And that means gold -- not Treasury bonds
-- would become an investor "safe haven."
You can expect gold prices to zoom up, peaking at a much higher
level around the time Bernanke is finally replaced.
Silver will also follow this trend
. So make sure you have substantial holdings of either physical
gold and silver or the exchange-traded funds SPDR Gold Trust (
) and iShares Silver Trust (
Second, if you want to profit more directly from the collapse in
Treasury bond prices, you could buy a "put" option on Treasury bond
) on the Chicago Board Options Exchange. The futures were recently
trading around 94, and the January 2013 80 put (CBOE:
) was priced around $4.50, which seems an attractive combination of
low price and high leverage.
Finally, if you don't already own a house, you should buy one --
and do so with a fixed-rate mortgage. A U.S. Treasury bond market
crash will send mortgage rates through the roof, so today's rates
of about 4.8% will represent very cheap money indeed. Even if house
prices decline by 10%, a 2% rise in mortgage rates would increase
the monthly payment (even accounting for a 10% smaller mortgage),
by a net 11.8% (the payment on a $100,000 mortgage at 4.8% is
$524.67; that on a $90,000 mortgage at 6.8% is $586.73).
Needless to say, the same benefits apply to rental properties
financed by fixed-rate mortgages: With lower home ownership and
rising inflation, rents are tending to rise significantly.
There's a storm coming in the Treasury bond market. But by
recognizing its approach, we can turn the bond market crash to our
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