This is a long term analysis covering bonds and interest rates and their relationship using The 54 Year Interest Rate Cycle and the related Kondratieff Cycle as well as Elliott Wave Theory. The Elliott Wave Principle is based on the psychology of the masses which forms patterns. I use these patterns as well as the general sentiment in my forecasting. In addition, I take into consideration the behaviour of the commercial traders.
I begin by looking at bonds and interest rates long term price patterns. Looking at charts spanning centuries, interesting structures are revealed which give an idea about the future of bonds and interest rates. The 30 year chart reveals a major structural turn for the bond market. An interesting aspect is that the same major structural turns take place in the currency market. See our analysis "currencies - Long term forecast" with the long term outlook for the worlds major currencies.
The irony is that in spite of the historically low interest rates that we have, debt crises are developing in Europe, Japan and United States, The bond market (also known as the debt, credit, or fixed income market) is a financial market where participants buy and sell debt securities, usually in the form of bonds. Because of the inverse relationship between bond valuations and interest rates, the bond market is the conductor of long term interest rates. Declining bond prices means rising bond yields and interest rates. Rising bond prices means lower yields and lower interest rates.
A History of the Modern Bond Market
The Money Prophets
The Rothschild family from its modest beginning in the aftermath of The French Revolution, created what was to evolve into the major banking house in Europe. The founder Mayer Amschel Rothschild sent four of his sons Nathan, James, Salomon and Carl to London, Paris, Vienna and Naples respectively, his other son also called Amschel remained in Frankfurt with his father. This multi national operation throughout Europe enabled them to have full advantage of the British Industrial Revolution during the 19th century.
The Modern Bond Market
The Rothschild's were the prime market maker for government bonds during the 19th century. They created the international bond market in its modern form which made bonds more easily tradable. Coming out of the turbulent and chaotic 18th century, the European states in the 19th century often ran budget deficits. Their tax revenues was insufficient to meet their expenditures which were usually related to wars or preparation for wars. The interest they had to pay was relatively high because they were perceived by investors as unreliable creditors due to the 18th century's wars and revolutions. The formula of the Rothschild's success in the bond market seemed to be secrecy, smuggling and risk taking.
The secret dealings between the Greek State and Goldman Sachs and the exceptional secrecy of the Vatican bank operations is likely to be the trend in the coming decades similar to the one of the 19th century. Once again the Rothschild formula is in use.
The Kondratieff Cycle and the 54 Year Wholesale Price and Interest Rate Cycles
Here is a summary of our analysis of the interest cycle published in "The Kondratieff Cycle" from 1st of December 2009:
Source: The above chart from The LongWave Group illustrates The Kondratieff Cycle through the centuries. On average the cycle is approx. 54 years long. This time the cycle is much longer. The graph also shows the comparison of interest rates and wholesale prices which are more or less following the same cyclic period. You can make a case that the Kondratieff cycle has topped and points down into 2020.
A fourth cycle or the current cycle began sometime after WWII (late 1940s) with the spring phase and we are now through with the summer and autumn (plateau) phase. Assuming that the winter phase of the cycle began around 2000, how can we identify the bottom or the end of the winter phase and the whole cycle?
Schumpeter had the opinion that the decline will continue below the point of equilibrium, and only when the debt structure has been restored to a sound basis will the economy reach this point. However, considering the growing debts as well as the fact that no one has claimed that the debt structure has been restored to a sound basis, we are still within the downtrend phase of the cycle and the bottom is in front of us sometime during the next decade.
Two of the long term cycles that are expected to be bottoming during the next few years are the 54 year Wholesale price Cycle and Interest rate Cycle. Ideally, these cycles should have bottomed in 2006 but the bottoming is still in progress. The historical low may have taken place late 2008. Our research indicates that these cycles could turn up after June 2011 (The next bottom in the Martin A. Armstrong Princeton Economics 8.6 year cycle). The next ideal top in wholesale prices and interest rates is expected in 2033 and this means that we will have more than 20 years of rising prices and interest rates ahead of us.
Learn more about cycles, Kondratieff and Schumpeter in our analysis called "The Kondratieff Cycle".
A Century Look at Interest Rates
The first interest rate cycle after the French revolution peaked in 1813 and declined until 1844.
A new rising wave of interest rates in the 2nd cycle commenced in the middle of 1840s and continued to the early 1870s. From the middle of 1870 interest rates declined until 1897. The 3rd cycle of rising interest rates topped in 1921 and declined until the end of WWII. Finally, one and a half century decline of interest rates ended by WWII. Each of these cycles had lower tops and bottoms compared to the previous cycle.
We can identify an approx. 54 year cycle during the last 300 years with the last bottom in the late 2008 and the previous bottom in the 1940's. The last peak in the cycle was in 1980.
From the French Revolution until WWII, bonds were rallying with higher highs and lower lows in their 54 year cycle.
Our main scenario is that WWII ended more than a century long bull market in bonds. The following decline continued until 1980 which we have labeled as wave I. Since then bonds have rallied in a wave II upward correction which most likely ended late 2008.
The 30-Year Bond
Here is a monthly chart of the 30-year US Treasury Bond price, illustrating the Elliott Wave counting of the upward correction in bonds over the last 30 years.
All charts in this article where source is not specifically given are courtesy of Stockcharts.com.
It looks like a 5 wave decline is in progress since the peak in late 2008 which we have labelled wave 1 in black colour. We are currently in the latter stages of it. You can expect some more downside on bonds before wave 1 is completed.
The next top in the interest rate cycle is expected in 2033 or a few years later which we assume would be the top of wave III of a century rise in interest rates. Bonds will of course decline during the same period as interest rates are rising.
10 Years Bonds
Here is a monthly chart of the 10-years US Treasury Note Price:
Bonds peaked long term late 2008 after rising since 1980. A near 30 year bull market in bonds is over and we are in the early stages of a long term decline which should last decades.
Interest Rates and bond yields
WWII ended more than a century long decline in interest rates. The first large rise in bond yield and interest rates commenced in the 1940's and ended in 1980. This was a wave I of what we believe will be a century rise in interest rates. Since 1980 yields and interest rates declined in a wave II correction which was completed at the end of 2008.
30 Year Bond Yield
Here is a monthly chart of the 30-year T-Bond Yield:
The Elliott Wave counting of the correction in bond yields reveals a declining zigzag pattern since 1981 that ended in late 2008. A near 30 year decline in interest rates is over and we are in the early stages of a long term rise.
The next top in interest rates is expected in 2033 or later. We assume that long term bond yields and interest rates will be considerably higher than 20% yearly in the United States and most other developed countries during the 2020s.
Bond & Interest rates compared to other asset classes
We compare bonds & Interest rates to the general stockmarket and precious metal represented by gold. We use this in a bull and bear market to see which one is the strongest and weakest.
The Bond / Stockmarket Ratio
The above ratio shows which one of stocks and bonds are the best performing asset class. Currently the stock market is outperforming the bond market.
Bonds outperformed stocks during the last decade and returned 6% per year on average while stocks lost money each year on average.
Gold / Bond Ratio
Gold relative to interest rates is topping long term. The decline should last decades, this means that you will make more money shorting the bond market than investing in gold.
The Bond Market Can Forecast Liquidity Waves
The Credit Crunch Indicator
A parabolic steepening of the US Treasury’s yield curve is topping / rolling over. The above indicator divides the long term 10-year US Treasury yield by the short term 3 months US Treasury yield and tells you when a credit crunch is brewing. This occurs when short term interest rates are higher than long term interest rates. Notice that this happened in 2000-2001 and in 2006-2007 leading to a substantial stock market decline both times.
Our Present Time - The Worlds Most Vulnerable Bonds
The Bond Vigilantes
The following chart is showing bond shorting activity and indicate which countries are the most vulnerable to default on their debt obligations. The worst ones all seems to be in Europe.
Source: Data Explorers
Many of the same countries are showing up in the The Misery Index as well. No surprise there:
The Misery Index, Moody's, the international financial ratings agency, has provided an interesting international comparison of financial misery. The misery index is a country’s fiscal deficit and unemployment rate as a percent of gross domestic product added together.
How To Trade a Long Term Decline in Bond Prices
TBT Ultrashort 20 year bonds is a vehicle for shorting bonds or to go long with the trend of rising bond yields. It simulates 2 times shorting the 20 year bond. PST is the ticker for shorting the 10 year bond or going long on 10 year interest rates. These are trading vehicles that do their jobs relatively well. You can see that TBT has been rising since the bond market topped in late 2008. You can also use options and futures.
However, if you use trading vehicles like TBT, PST, options or futures timing is important. To be successful you must be a market timer and ride the waves. BUY and HOLD will not necessarily work that well using this kind of trading vehicles incl. options and futures because of the time factor which deteriorates the value of them.
We expect rising interest rates and bond yields until the end of the century. The result will be mass defaults and bankruptcies of nations, municipalities, corporations and individuals. Therefore we expect a chaotic and turbulent 21st century.
Interest rates and bond yields have bottomed long term in their 54 year cycle and should rise for decades in a wave III of the next cycle. Bonds have peaked and should decline for decades in wave III. You can expect that a number of countries, municipalities and corporations will default on their bonds and interest rate payments in the coming years.
From the middle of the 2030's we expect a IV wave correction in bond yields and interest rates which will last for decades possibly until around 2060 when the next 54 year interest rate cycle is expected to bottom. This will be followed by a rise in interest rates in wave V until the end of the century. Bond prices should naturally decline during this period in wave V.
Intermediate bonds will soon rally in a small wave 2 upward correction that might last until the end of 2010 / early 2011. Interest rates are expected to decline during the same period. This creates the biggest shorting opportunity in the bond market for centuries.
Copyright © 2010 Geir Solem