62: How The Biggest Bull Market Could Come Crashing Down

Episode Summary

Executive Summary: The episode examines whether the long bull market in bonds is ending, using Paul Schmelzing’s 800-year history of sovereign yields to frame current sell-offs. He argues today’s risk may be a dangerous blend of 1960s inflation pressure and a 2003-style VAR-driven bond dump, creating a potentially severe drawdown for investors, banks, and pension funds.

Main Topics: Bloomberg promo and Stock Movers introduction (Priority: 1/5): A short promotional segment introduces Bloomberg’s Stock Movers, a brief audio market update product distributed across podcast platforms. Why bond markets matter now (Priority: 5/5): The hosts explain that the recent bond sell-off is significant because government bonds have been in a multi-decade bull market and a reversal could inflict large losses across the financial system. 800 years of bond market history (Priority: 5/5): Paul Schmelzing outlines his historical dataset beginning in 1285, tracing sovereign bond yields from Venice to the U.S. Treasury market and showing the current bull market is among the longest and largest ever. Pre-modern bond reversals and geopolitical shocks (Priority: 4/5): Before the 20th century, bond bull markets often ended when wars, military defeats, defaults, or punitive actions against bankers undermined issuer creditworthiness. Modern sell-off case studies (Priority: 5/5): Schmelzing highlights three modern analogues: the late-1960s inflation reversal, the 1994 bond massacre, and Japan’s 2003 VAR shock, each showing different mechanisms for bond losses. Potential blended downside scenario (Priority: 5/5): The current environment may combine inflationary pressure with forced selling from risk models, potentially making the next bond downturn worse than prior episodes. Regulation, safety, and unintended consequences (Priority: 4/5): The discussion closes by noting that post-2008 rules pushing institutions toward safe assets may concentrate risk in government bonds and amplify stress during a sell-off.

Key Arguments: The current bond bull market is historically extraordinary in length and yield compression, making any reversal potentially consequential. Pre-20th-century bond reversals were usually driven by sovereign credit events, military defeat, or political upheaval rather than macroeconomic pricing dynamics. Modern bond sell-offs are more likely to come from inflation surprises, leveraged positioning, and model-driven liquidations than outright sovereign default. The late-1960s U.S. experience shows how fiscal stimulus plus tight labor markets can drive inflation higher and damage bond returns. The 1994 bond massacre demonstrates that bond losses can be severe even when fundamentals do not deteriorate much. Japan’s 2003 VAR shock shows how internal risk-management rules can force institutions to sell bonds, intensifying volatility. Current conditions may be more dangerous because inflation pressure and VAR-related selling could occur together. Regulatory incentives that push banks toward government bonds can create concentration risk rather than eliminate it.

Data Points: Start of historical dataset: 1285 - Schmelzing begins his sovereign bond history in the year 1285 with Venetian and Genoese markets. Duration of current bond bull market: About 3 decades - The current bond bull market, begun around 1981, is described as lasting roughly thirty years. Lowest U.S. 10-year yield cited: Below 140 basis points - Last July’s U.S. 10-year yield was described as the lowest nominal risk-free rate in nearly 800 years. Cumulative yield compression since 1981: About 1200 basis points - The long decline in yields over the current bull market is measured from 1981 to the present. Earlier comparable bull market compression: 1440s to 1480s - A 15th-century bond bull market is cited as the only one exceeding the current cycle in yield compression. Longest historical bond bull market: 1558 to 1664 - A nearly 100-year bond bull market in the Venetian era is cited as the longest by duration. Fiscal stimulus in the late 1960s: About 250 basis points to GDP - Used to describe the Vietnam War-era fiscal expansion under Lyndon Johnson. CPI inflation in the 1960s case study: From 1.5% to close to 6% - Inflation rose sharply during the second half of the 1960s as rates and labor-market tightness interacted. China PPI inflation print: 5.5% - Cited as a recent example of inflation pressure relevant to bond markets. German inflation acceleration: Highest speed in 23 years - Used to illustrate broadening inflation momentum globally. U.S. average hourly earnings: Almost 3% - Presented as evidence of ongoing wage pressure in the U.S. labor market. Losses in 1960s bond bear market: Close to 40% in real terms - Long U.S. Treasury investors lost this much over four years in Schmelzing’s inflation reversal example. 1994 global bond value loss: $1.5 trillion - Schmelzing describes 1994 as the most violent year for long-bond investors. 1995 real bond return rebound: 18% - He notes that bonds recovered strongly after the 1994 sell-off once speculators were washed out.

Pivotal Quotes: "Venetians, Volcker and Value at Risk, Eight Centuries of Bond Market Reversals" — Paul Schmelzing (post title cited by hosts): The title of Schmelzing’s Bank of England blog post encapsulating the paper’s historical sweep and modern relevance. "I think this is one of the most remarkable bond bull markets in all of recorded economic history." — Paul Schmelzing: His assessment of the current multi-decade decline in yields and the scale of the bull market. "we are probably heading for something worse than the 1994 Bond massacre" — Paul Schmelzing: His warning that the present mix of inflation and risk-model selling could exceed prior modern bond sell-offs.

Implications: Investors and regulators should treat bond-market risk as systemic, not niche. If inflation, rate pressure, and VAR-triggered selling combine, losses could cascade through banks, pensions, and leveraged portfolios, making government bonds far less stable than their “risk-free” label suggests.