The Treasury Bond Collapse is Real.

With interest rates rising almost everywhere around the world, we are now facing yet another financial meltdown. I know, here we go again, right? But this time, there might just be some weight to the reports. By the end of this video, you'll discover why the bond market is currently collapsing, why people care so much about bonds, and whether you'll be affected by what Bank of America is calling the greatest bond bear market of all time.

People are underestimating the potential weakness in bond markets. US Treasury bonds are a pretty safe investment unless you have to go and sell the bonds. The Treasury increased interest rates, and when interest rates rise, bond prices fall. When rates move the wrong way, losses can mount in a hurry. You might have seen articles like this floating around lately: "The 10-year US Treasury yield touches 5% for the first time since 2007." At first glance, this sounds like a good thing, right? But right now, many investors holding the safest bonds in the world, US Treasury bonds, are currently watching the value of their portfolios crater more than 50%.

But what do I mean by this? How does this work? Well, let's understand how a bond works. Unlike a stock, where we don't know what the future holds, with a bond, you know exactly what's going to happen. It's printed on the bond. If the Treasury offers you a 10-year bond with a 2% coupon, you know you're going to give the Treasury, say, $1,000 today. You'll receive 2% per year, and then at the end of the 10 years, they're going to give you the $1,000 back.

Now that's in effect because if you hold the bond through to its maturity, you know exactly what you're going to get. But here's the thing about these bonds: once you buy them, they can also be traded between investors on the open market. You don't have to sell them early, but you could turn around and sell them if you wanted to for the current market price. Now, this doesn't matter if you hold the bond through to maturity, but it does matter if you need to sell the bond prematurely for whatever reason.

Now let's think about this. Back in 2020, interest rates were basically zero, which in effect meant that when you bought bonds back then, you were agreeing to give your money to the Treasury for only a very small annual coupon. But over the last few years, interest rates have risen and risen and risen. The thing is, the Treasury, needing to finance its ever-growing annual deficit, needs to keep printing more and more of these bonds and selling them to investors now at higher interest rates. Short-term Treasury yields adjust upwards too, and that means investors can buy these bonds from the Treasury today and now get a 5% coupon per year, a much better deal than what they could lock in a few years back when interest rates were basically zero.

Now, once the short-term bonds increase, it takes a little while for the long-term bonds to catch up, but that's what we're now seeing at the moment. But these rising Treasury yields cause one key problem. Can you see where this is going? Think about this: why would anyone want to pay full price for a bond from 2020 with a 2% coupon when they can buy a freshly printed bond from the Treasury that gives them 5% per year? Exactly. What does this cause? It causes the market value of those older bonds to fall and fall and fall. The higher interest rates go, the more the old bonds lose their value.

Why do they fall in price? Well, to offer an investor a 5% yield like the new bond, investors need a steep discount on the purchase price of the old bond to compensate, remembering they'll still get $1,000 back at the end of the 10 years. This is why the positive headline that reads "10-year US Treasury yield touches 5% for the first time since '07" can actually be read quite negatively. So let's see this effect play out visually. This is the chart of the yield on the 10-year US Treasury bonds. As you can see, over the last few years, as interest rates have risen, so have bond yields.

But now let's look at something like this bond ETF that buys and holds 10-year Treasury bonds. What's happened to the share price of the bond ETF? Have a look. Since 2020, the bond ETF has lost more and more and more of its value. But this is where people are starting to call this a financial crisis. Have a look at how much this bond ETF has fallen over the last few years from its peak in 2020. The bond ETF has halved.

Now, if we're looking in the world of crypto, you know a 50% decline sounds pretty run-of-the-mill. If we're looking at the stock market, 50% declines are rare, but they can occasionally happen. But to see a 50% decline in bond prices, assets that are usually bought for being nice and stable and low risk? Well, 50% declines are pretty unheard of and can cause major havoc.

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But back to it. So overall, you've got this dynamic of interest rates rising, and thus old Treasury bonds held by investors are getting less and less valuable. At this point, as I was saying before, investors are staring down the barrel of unrealized paper losses of over 50% on the bonds they bought back in 2020. As Bloomberg notes, 50 cents on the dollar is a very low price in the world of bonds. Remember, bonds are usually bought by risk-averse investors seeking stability. They're not the type of investors whose stomachs can handle 50% drops very easily.

Bank of America is calling this the greatest bear market of all time in the bond market, and it's not hard to see why. But here's the thing: this whole event is both a major issue and also a complete non-issue. It all comes down to whether you need to sell your bonds or not. Remember the special thing about bonds: when you buy them, you know what you're going to get. What you're going to get is printed on the bond. If you hold your Treasury bond until maturity, you get your coupon payments and you get your money back. You aren't being forced to sell your bonds on the open market where the value is collapsing. So while you might be experiencing a massive loss on paper, if you can just make it to the maturity date, you don't actually lose any money at all.

You might lose money in real terms because inflation might roar in the time that your money is locked down, in which case you've locked down your money and you haven't even kept up with the inflation during that time. But in terms of your actual investment in the bond itself, you won't lose money. So why then are people calling this major bond selloff a new financial crisis? Well, because not everyone can hold on to their bonds until maturity. So it is a major crisis for those who need to sell their bonds to get their hands on short-term cash.

This is exactly what caused the banking crisis earlier this year, a crisis that some believe might have a second inning. If we take Silicon Valley Bank, they had a massive amount of bonds on their balance sheet they bought back in 2020. But as the businesses that banked with SVB started to struggle and withdraw their money from the bank, SVB didn't have enough cash immediately on hand to be able to meet the withdrawals. So they had to sell some of their bonds to come up with the cash. The only problem was they had to sell while the bonds were worth just a fraction of what they bought them for, thus locking in large losses just to meet withdrawals.

They then reported these losses during their earnings, which spooked depositors about liquidity, which triggered even more withdrawals, which locked in more losses on their bonds, and bang, the whole thing imploded. While that banking crisis has settled down for now, it is worth noting that this isn't an isolated issue. All banks typically have large amounts of Treasury bonds, and that's why there was and continues to be a massive volume of chatter around bank runs.

Earlier in the year, we saw a few regional banks fail, and the general worry around small to medium-sized banks still exists today. The good thing is that most banks, particularly the large banks, likely won't have to sell their bonds to cover withdrawals. So even though they are sitting on large unrealized paper losses, this likely won't cause any major issues in the financial system. The annoying thing for them, though, is that they've unfortunately tied up a lot of cash in bonds during a really low interest rate period.

So now that these bonds are offering around 5%, they unfortunately don't have all that much cash to take full advantage. So overall, that's the story. But there's just one more thing I wanted to cover in this video that you might have heard about lately as well, and that is the inverted yield curve. What on Earth is this about? Well, I just want to go a little bit deeper on the bond example from before and explain it.

So before we were talking about how when interest rates rise, this means that new Treasury bonds pay better, and it means the old pre-existing bonds drop in value. Now that's all correct, but one interesting thing you may not know is that the Treasury issues lots of different Treasury bonds with different maturity lengths. They can issue a bond that matures in a few months, few years, or even 5, 10, 20, or 30 years.

Typically, the longer you tie your money up for, the higher the interest rate you expect, right? If I'm going to tie up my money with the government for 10 years, they better pay me well for that. Now, if we map that out on a chart, this is what it looks like: as time goes on, interest rates get higher. But what we're seeing right now is actually the opposite. You can get a better coupon rate on a shorter duration bond than a long-term bond.

As I touched on earlier, this happens because short-term bonds react to interest rate hikes much faster than long-term bonds. But this inverted yield curve is an abnormal phenomenon, and now as time goes on, we're starting to see this yield curve normalize. Hence, the long-term Treasury yields are rising and hitting their highest levels since 2007.

But that’s not the only reason for the normalization of the yield curve. With the labor market still extremely strong and inflation bouncing back a bit, the Federal Reserve has also hinted they're going to keep interest rates higher for longer. What this does is it gives confidence to investors to buy more shorter-term bonds, pushing down their yields, and abandon their longer-term bonds, pushing up their yields. The thinking is: why would I stick around with my long-term bonds that are not really giving me the best return when I can just buy these shorter-term bonds at higher yields with interest rates likely to stay higher over the medium term? I could just keep rolling them over and cash in there.

So overall, that's why we're seeing these long-term Treasury bond yields start to rise, and a lot of bond investors are in pain. While on the surface it seems like positive news for investors, for those that are heavily in bonds already, they're facing a major financial meltdown that puts a large amount of pressure on their backs if they are unable to hold them all the way through to maturity. But with that said, guys, please leave a like on the video if you did enjoy it, subscribe if you'd like to see more, and that will do me for today. I'll see you guys in the next video.