The 3 reasons everyone is dead wrong about bonds
Have you sold bonds lately? You're not alone.
TrimTabs reports that bond mutual funds and ETFs have seen $114 billion in redemptions since the month of June—$30.3 billion of which has come between Aug. 1 and Aug. 19 alone. But that should probably come as little surprise, considering the Bank of America Merrill Lynch's August Global Fund Manager Survey showed that a mere 3 percent of investors think long-term bond yields will be lower in 12 months.
The obvious culprit is the Fed's tapering talk. Ever since Fed Chairman Ben Bernanke said on June 19 that "the Committee currently anticipates that it would be appropriate to moderate the monthly pace of [bond] purchases later year," the 10-year yield has risen from about 2.15 percent to 2.9 percent remarkably quickly. The concern is that the Fed will decide to taper its bond-buying program at its next meeting in mid-September, and that the reduction of buying support will cause bond prices to drop and yields to rise.
But Lawrence McDonald of Newedge says investors are getting the bond trade all wrong. In fact, he boldly claims that the 10-year yield will finish the year at 2.35 percent, and "maybe even 2.20."
So what are investors missing? McDonald on Tuesday spelled out the bond market's three biggest misconceptions on CNBC.com's "Futures Now."
1. The Fed will taper to make rates rise
Many investors believe that a rate rise is precisely what the Fed wants.
As Rhino Trading Partners' Michael Block told CNBC.com earlier this week, the rise in rates "is Fed induced. The Fed started talking about tapering because they wanted to avoid an overdone situation in credit and housing, and I think the Fed succeeded in doing that."
(Read more: For bond investors, it feels a lot like 1994)
Similarly, "Futures Now" contributor Jim Iuorio wrote on Tuesday that he believes the Fed will "continue to massage rhetoric in order to engineer higher rates."
But McDonald calls this malarkey. Referring to the rise in rates, McDonald said: "I don't think they want it at all, because they've been on this dovish march for three months, and they haven't been able to control the long end."
To McDonald, the Fed is seeing action in the market that they must hate. "If you look at one of the homebuilder indexes on construction, it's now in a bear market. I mean, are you kidding me?"
Indeed, the iShares Dow Jones US Home Construction ETF (ITB) dropped 22 percent from May 15 to Aug. 15, marking a bear market.
"So the strongest part of the U.S. economy—probably the strongest part of the global economy, U.S. housing—the major ETF in U.S. construction now has entered a bear market," McDonald emphasized. "That tells me that the Fed is very concerned about what happened on the long end of the yield curve to mortgage rates."
(Read more: Mortgage rate spike finally hits housing)
Because of this concern, McDonald doesn't see the Fed tapering in September or October, as many investors anticipate. "If you look at the economic data that's coming out over the next couple weeks, you could get a little more pushback in the timing of taper," McDonald said. "I think a lot of tapering is priced in. They may push back tapering by a month or two, and then you'll get a pretty sharp rally here in bonds."
2. Larry Summers will become Fed chairman
McDonald says that a lesser-noted rationale behind the recent bond selloff has been a changing perception over who will replace Bernanke. The leading contenders are seen as Larry Summers and Janet Yellen.
"I think one of the reasons why bonds have sold off so much is that the market is clearly pricing in a Summers appointment," McDonald said.
(Read more: Twitter is going crazy with Larry Summers Fed buzz)
The issue is that Summers appears to have quite different views from Bernanke about quantitative easing. At an April conference, Summers said: "QE in my view is less efficacious for the real economy than most people suppose."
Yellen, on the other hand, is seen as much more comfortable with quantitative easing, and is viewed as having a similar stance to Bernanke on major issues.
(Read more: Summers vs. Yellen: Who are their supporters?)
But while Summers' anti-easing remarks displease the bond market, they might also displease the Obama administration.
"Larry Summers has been critical of QE, which doesn't really jibe with what the Obama administration wants," McDonald said. "You'd think the Obama administration, going into the 2014 [midterm] election, wants more QE, right? So it's bizarre—Larry's record is very, very negative on quantitative easing, he's questioned the validity of it, and now the market's pricing in a huge divergence between Summers and Yellen."
On this issue as well, then, McDonald thinks bond investors are getting unduly bearish.
3. There's only one way that yields can go
The final reason McDonald is buying bonds? Everyone else is selling.
The bond market today "reminds me of the June 27th low in gold," McDonald said. "And now the gold miners are up 38 percent from that day."
The recent move has been extreme, he noted. "Since Lehman, there have been only two times when the 10-year Treasury yield has traded 85 points above its 200-day moving average," said McDonald, who writes at LawrenceGMcDonald.com.
Such a move "is extremely rare," McDonald said, adding: "It's a great opportunity to buy long-term bonds."