Bond yields have fallen to their lowest levels in 14 years, and fixed-income investors are filled with optimism. The total return on bonds is higher than the total return on stocks, and almost everyone seems to think inflation is under control.
From what we can see, this bull market in bonds will continue a good while longer. The economy has no strength, and it will continue to lack any driving force as it continues to adjust to the end of the Cold War and the over-leveraging of the 1980s.
The Federal Reserve is committed to lower short rates, and fixed-income investors are gaining confidence in extending the maturity of their holdings.
The Bond Buyer 20-bond index, which measures the yield of upper medium-grade municipal bonds maturing in 20 years, dropped to 5.89% last Thursday, its lowest level since April 1978. That's 7.55 percentage points below its historic high of 13.44% set in mid-January 1982.
The 20-bond index declined 90 basis points in the last four months alone, marching smartly downhill with little resistance until it ran into a roadblock last Thursday.
States and cities have taken advantage of lower interest rates to refund records amounts of their debt, and this sensible government strategy shows no sign of slackening. Moreover, investors haven't shied away from the record volume of new bond issues marketed this year at lower interest rates.
The market did recoil last Thursday, to be sure, but that most likely was temporary, not the start of a lengthy decline in bond prices and a return to higher yields.
As long as the economy continues to move ahead with almost no vigor at all, the bond market will remain in good shape. It's not hard to foresee long-term Treasury bonds, which yielded 7.43% last Friday, yielding 7% at yearend while the Bond Buyer 20-bond index follows along and reaches 5.50%.
The fundamental force at work here will be the changeover in the economy from one propelled by military spending to one based on something else. And until replacement for diminished arms manufacturing is found, business activity will remain soft and cyclical upturns will be small by historical standards.
The changeover in the economy is taking place at a time when the federal budget deficit is starting to be regarded differently, and that change, if it's real, will help the bond market.
Bond dealers remain skeptical, but some bona fide change in handling the federal budget deficit may lie ahead. This second half should be exciting for bonds.