Every year, there are trades that seem like no-brainers, but conventional wisdom ends up taking it on the chin.
The longest-standing of these losing trades, dubbed the widow maker, has been to short Japanese bonds.
Yields on Japanese debt, it has long been said, have nowhere to go but up, given the county's elevated indebtedness and deplorable demographics, which would make domestic pension funds net sellers of sovereign debt.
Shorting U.S. Treasuries, however, has fast become another trade that frustrates market participants.
Entering the past two years, when the Federal Reserve was poised to dial down its quantitative easing and embark upon a tightening phase, the commitment of traders reports showed hedge funds held massive short positions in 10-year U.S. Treasury futures. "Higher rates are just around the corner" has long been an unsuccessful consensus call, as modest economic growth and subdued inflation (recently in part because of tumbling oil prices) have combined to further depress bond yields.
When benchmarked against European bond yields, the 2.5-per-cent bond yield on U.S. 30-year government debt looks quite attractive, although the different currencies render an apple-to-apples comparison meaningless on the surface.
Moreover, Gluskin Sheff + Associates chief economist David Rosenberg pointed out in a note to clients that 80 per cent of the new Treasuries supply over the past year have been bought by foreign central banks, pension funds, insurers, banks, and insurance companies.
These entities, in Mr. Rosenberg's words, are ones "that need Treasuries, not want them."
No less an authority than Ben Bernanke, Fed chairman-turned-blogger-turned-hedge fund adviser, concurred that price-insensitive buyers are playing a large role in the market.
"New regulations require banks to hold ample liquidity and securities dealers to post more collateral in derivatives transactions," he wrote in a recent blog post. "Insurance companies and pension funds also face rules that effectively require them to hold significant amounts of safe, longer-term bonds. This mandated demand seems likely to put downward pressure on longer-term yields for the foreseeable future."
For bondholders, inflation – or a lack thereof – is the biggest wild card. Inflation both directly influences the nominal yield demanded by bondholders and also affects the term premium. This is the compensation an investor demands for holding a longer-dated security.
"All else equal, term premiums on longer-term securities will be higher when investors are more risk-averse and/or the perceived risk of holding those securities is high," Mr. Bernanke wrote. "Historically, the most important risk for long-term bondholders has been the risk of unexpected inflation."
So, what could give rise to inflation after years of meagre increases in prices across the developed world?
Inflation, as described by the famous Milton Friedman, "is always and everywhere a monetary phenomenon."
However, some, memorably Matt Busigin, portfolio manager at New River Investments, have explored other causes of rising consumer prices.
In November, 2013, an article written by Mr. Busigin, A Non-Monetary Explanation for Inflation, found "evidence that suggests productive capacity and velocity [the frequency at which money is exchanged in an economy], not money supply, have the largest impact on prices."
The non-monetary driver of inflation, according to Mr. Busigin, is population growth; more specifically, changes in the size of different age cohorts.
"Although the expenditures of retirees decline, they still spend a slim majority of their peak expenditures while not contributing to supply," he wrote. "At the same time, the marginal Millennial coming of age will replace the marginal retiring Boomers' demand, creating an excess of demand with the same level of labour."
Inflation, at the moment, is not on most investor's radar screens. Central banks in advanced economies are no doubt worried about it – but only because they don't have enough.
As such, a breakout in inflation (not hyperinflation, as some have claimed is "imminent" for years on end) is a likely prerequisite for the true death of the long bond bull. But since bond yields and inflation have been so low for so long and so many buyers remain price-insensitive, trying to call the bottom promises to be a deeply unsatisfying endeavour.