I read an interesting comment a couple of weeks ago, but unfortunately I don't know who to credit for it. The person said that with the Fed's announcement of QE2, it would give cover for the Chinese government to sell U.S. bonds. The Chinese government has a little under a trillion dollars in U.S. bonds. If and when the Fed keeps debasing the U.S. dollar, then the Chinese government will get paid back in dollars that are worth far less. In other words, U.S. bonds may be a bad investment to have and the Chinese government has a lot of them.
Let's say that Bill Gates wants to sell a bunch of his Microsoft stock. He would not sell it all at once. Doing so would tank the stock and he would get less money for the sale of his stock. He would sell it slowly so that he could get as much as he can for it. The same goes for the Chinese government or another major holder of U.S. bonds like the Japanese government. To the individual bond holder, he can sell at any time and he doesn't have to worry about moving the market in any significant way. If a foreign government that owns hundreds of billions of dollars of U.S. bonds wants to sell, then it can't just sell it all at once or it would crash the bond market.
With the Fed's announcement of QE2 and buying $600 billion or more in U.S. bonds, it provides a buyer to those who want to sell. All of a sudden, it would make sense for the Chinese and/or Japanese governments to sell their bonds since they have a willing buyer in the Fed. This would have the effect of preventing interest rates from going lower, which is actually what we've seen since the Fed announced QE2.
This is all under the assumption that foreign governments would want to sell their U.S. bonds. It makes sense to me why they would, but these politicians aren't always that bright, so it is hard to say what their mindset is. But don't be surprised to see interest rates not go down while we see a big increase in the adjusted monetary base. Wouldn't it be ironic if the Fed's big QE2 announcement to lower interest rates simply provides cover for the Chinese to sell their bonds? It may be the perfect way out of the falling dollar for the Chinese and others.
The bond market is very unpredictable in the short run. Other than a small portion for your permanent portfolio, I wouldn't bet a lot either way on bonds these days. There will be a good time to short the bond market. It might be now, but I still wouldn't bet against the Fed and its money creation. Interest rates will eventually go up, but the Fed still may succeed in the short-term of keeping rates fairly low.