Ready for a bear market in bonds?

Federal Reserve Chairman Ben Bernanke's prepared comments for the House Budget Committee on Feb. 2 were not at all earthshaking, and I must admit I had the stomach to listen to only a small snippet of the Q&A.

Yet one bit of his testimony that I did see said it all -- that the Fed might "bring inflation up to target" if necessary. That implies not only that the Fed knows what the right target is for inflation, but that it can hit said target.

Past performance no guarantee of . . . oh, never mind

However, if you take a step back and examine all the things that Fed leaders have gotten wrong, then consider the idea that they think they can thread the needle precisely enough to fine-tune the exact inflation rate (which is all the more humorous because inflation data are completely bogus), you can quickly see how big of an opinion they have of their own opinion.

I continue to find the Fed's arrogance rather amazing. If you read Bernanke's statements from 2004 to 2006, you will realize he was completely clueless about the housing bubble -- and, of course, he certainly doesn't believe that the Fed caused it.

Thus, for a guy who did not even see the most obvious bubble in the history of the world, it strikes me as the height of hubris for him to think he can pick not just the right interest rates (since they are essentially at zero now) but the right inflation rate to target in order to make the world hum the way he likes.

Of course, to repeat something I have been saying for almost 20 years, the Fed is the problem because it continually picks the wrong interest rate -- always too low -- which leads to a train wreck. Then it comes back and prescribes more of the same medicine. Now that rates are near zero, and the Fed has committed to keeping them there for a few more years (read "All roads lead to inflation" for more on this decision), the only medicine it has left is goosing the money supply through bond buying, i.e., quantitative easing.

I believe we are headed to the next phase of this process, whereby the bond markets of the world are going to demand more in the form of interest rates than the central bankers want to give them, because the fears of a deflationary misstep will likely abate. Though that is not yet today's business, it looks to be where we are headed.

Liquidity hogs turn up noses at money trough

On the subject of bonds, I noted that in the wake of Tuesday's promise of continued liquidity (by Bernanke, this time testifying in front of the Senate), which aided stocks and commodities, bonds were hit hard. That is not a development we have seen very often, as the liquidity hogs in the bond market have typically lapped up any news regarding the Fed's easy-money policies over about two decades now.

I certainly don't want to make too much of one day's action. But if we get into a period where the bond market routinely sinks on the notion of more liquidity, or a lack of potential deflationary disasters, we may, in fact, finally be in a secular bond bear market, following the 30-year secular bond bull market.

I don't think we can draw too many conclusions until we see how markets behave after the next round of money printing (sorry, I mean "long-term refinancing operations") by the European Central Bank later this month. But if the Europeans manage to take worries about a deflationary accident off the table, and kick the can down the road, I can't imagine the bond market staying where it currently is.

Thus, it may pay dividends to follow the bond market action closely a few weeks from now, and I intend to be alert to the possibility of a nasty sell-off in bonds, and potentially the start of a bear market in them.

In my opinion, that would be the catalyst for true bond vigilantes to take the printing press away from the central bankers, which would mark the end of the all-paper reserve currency (i.e., dollar) experiment begun in 1971. (Find out more about the so-called "Nixon Shock" of 1971 here.)

That will mean a difficult period, but it would give us the chance to pursue sound economic policies for the first time in about 50 years (excluding the Paul Volcker period of 1980-87.)

Back to work, or back to the drawing board?

I was surprised at the enthusiasm with which writers greeted the employment data that generated so much discussion on Feb. 3.

While it is clear that the report was an improvement over what we have seen, there are enough questions that it is not possible to draw conclusions about the validity of the strength.

My suspicion is that the jobs market is not as strong as that report would have us believe, but we are simply not going to be sure until we see what the next couple of months bring. Certainly, those who are already enthused about the real-estate markets are getting ahead of themselves.

One research service I subscribe to spent a good deal of time and effort looking into the employment data in a recent letter to clients, and the most salient point was the fact that in January we had an actual loss of 62,000 manufacturing jobs, which turned into a gain of 50,000, thanks to seasonal adjustments. Of course, to think that we actually lost 62,000 with the weather as warm as it was shows just how weak the underlying economy is.

My buddy, tech stock guru Fred Hickey, lent support to this view as well. He pointed out that the knuckleheads on Bubblevision have recently been positively salivating over the strength of the economy, even though virtually all of the major tech companies reported revenue problems as of December, including IBM (IBM, news), Intel (INTC, news), Microsoft (MSFT, news), Juniper Networks (JNPR, news)and especially Google (GOOG, news)and Amazon.com (AMZN, news). (Microsoft owns and publishes MSN Money.)

Thus, there is not much chance that anomalous "good news" like the January jobs data will divert Bernanke from the path he is on. Even if the Bureau of Labor Statistics decides to get even cleverer, voters are still going to know that if somewhere between 9% and 15% of the population is unemployed, or underemployed (as is the case currently), it doesn't really matter what the official rate is.