US Bond Market Rally Continues

The slow and relentless rally in the US bond market has been anything but traditional because no one is waving the white flag over a drastic slowing in the US economy or a collapse in risk assets.

Although first-quarter growth forecasts have dropped toward 1% (which now seems to be an annual event), second-quarter forecast sits at a very robust 3.3% even with Friday's weaker inflation and retail sales data, Bloomberg reported.

It can be a mistake, but the Federal Reserve's probable course of action wouldn't change even if growth came in at 1.5% with a 4.5% unemployment rate. Also absent in this bull market is a precipitous drop in crude that has moderated inflation fears in past rallies.

In fact, oil is comfortably back above $50 a barrel. So, with growth coming in above potential and inflation at or near the Fed's targets, much of the causation of this latest move in bonds falls into two categories: Washington gridlock and geopolitical fears.

While there are geopolitical issues right now around the globe, strategist David Nelson told CNBC there are "more sinister things" happening in the bond market right now.

He called the 10-year US Treasury's drop last week below 2.3% "kind of a line in the sand" because he's been looking for yields to break out to the upside, to about 2.6%. That, he said, would confirm the reflation trade and the market rally.

"We're breaking down now. You've got the long end of the curve coming in. You've got the short end of the curve going up because the Fed is starting to hike rates. You're starting to flatten the yield curve," the chief strategist for Bellpointe Asset Management said in an interview with "Power Lunch."

A Possible Recession?

"At some point in time, economists are going to start using the 'r' word," he said, referring to a recession.

On Monday, the benchmark 10-year US Treasury note broke below 2.2% for the first time since Nov. 17 before bouncing back to around 2.25. At this point, Nelson said he can't stick his head in the sand. He said a recession is "a possibility".

And while a rush into Treasury is expected during times of geopolitical tension, it isn't the only thing weighing on investors, he said. He thinks the biggest issue is what's happening with President Donald Trump's agenda.

He has said his first order of business is to get the Republican health-care bill passed before hitting tax reform and infrastructure spending.

The second geopolitical flash point is North Korea. No shots have been fired but the potential for a cataclysmic event is much higher given the unpredictable nature of North Korean leadership. The country's nuclear weapons program leaves Japan and South Korea in a state of permanent dread.

China's Dollar Bond Market

China’s dollar bond market has a diversity problem. As borrowers raised a record $51.7 billion in dollar-denominated debt this year, Chinese banks bought about half of the notes, according to UBS Wealth Management. US-based money managers only got access to 7% of the deals, down from 46% in 2014, data compiled by Bloomberg show.

The domination of China-based investors is fueling angst about the potential fallout if they all get cold feet at once, especially with $195 billion of dollar notes maturing over the next three years. Risk of a regulatory crackdown on wealth management products and a strengthening yuan are near the top of the worry list: after three years of depreciation spurred Chinese buyers to load up on dollar assets, the currency’s gains in 2017 put that trend in jeopardy.

“Aside from market and credit risks, the biggest risk that could force Chinese investors to cut dollar-bond holdings is yuan appreciation,” said Wu Xiangjun, an overseas bond fund manager in Shanghai at Guotai Asset Management Co.