How long can the Fed pump up the US bond bubble? Time to shift into hard assets?

By: Peter Cooper, Arabian Money

The most obvious bubble in the global financial system is the US bond market and by far the biggest today. Holding interest rates until late 2014 as the Fed announced yesterday should hold it stable for another three years.

In theory holding rates low ought to encourage bond holders to exit this market. The return on this investment is negative after inflation, a guaranteed loser for capital holdings not a preserver of wealth unless you think the other options have even more downside.

Fear trade

It is a fear trade. Equities rallied very modestly on this news. In previous years stocks might have surged as the yield on equities is far higher than the yield on bonds, or at least still in positive territory.

But then stock markets around the world have lost their momentum and volumes. Famous market timer Jo Granville thinks the game is up and the Dow Jones will plunge 4,000 points this year (click here).

It is an extreme forecast but these are extreme times with the eurozone on the brink of tipping the world into a second global financial crisis and the Iranian dispute threatening $140 oil this summer according to the IMF.

Reason enough to be cautious. But as Dr Marc Faber continues to warn investors the US T-bond just has to be a long-term loser at these levels of interest rates. How long is the long-term? Is it beyond three years or within that timetable?

Certainly the Fed is preparing the market for QE3, a second round of electronic money printing which it is desperately keen to keep as a policy response to the imminent eurozone crisis.

But investors must surely scratch their heads. How much money can be pumped into the global economy before you get much higher inflation? Which asset classes will benefit from inflation and which lose? Bonds definitely look a loser, for how long can the Fed actually keep rates at these levels?

The Central Bank of Italy would love to keep its rates near zero but the market has long taken over, and low ECB rates mean nothing for Italian bonds. The ECB still has Germany as its benchmark and financial bulwark. The Fed has the heavily indebted United States.