Blain’s Morning Porridge – Jan 13 2021: Bond Consequences?
“Weebols wobble but they don’t fall down..”
This morning’s comment is going to be brief for two reasons. 1) I am busy on a deal, and 2) it’s about bonds, which are definitionally boring and I don’t want held responsible for readers falling asleep at their desks….
US bond yields have been rising since New Year, so yesterday’s US 10-year Bond auction was more interesting than most – the market was looking carefully for signs, signals and auguries of further rises in bond yields to come: a Bond Bear Market! I even read that most dangerous of comments: “bond yields have reached an inflection point”, according to one bank rates strategist.
Should we pack our bags and run for the hills in terror and fear of a looming bond market panic? (If you are not a fixed income/bond market aficionado perhaps I should make clear: rising bond yields are a bad thing meaning prices fall, and rising prices mean yields fall. Clear? Excellent.. let us proceed.)
Watch bond yields very carefully. I’ve spent my career in finance believing the basis of everything is: In bond yields there is always truth.
However, the first thing is that truth is about the last thing many folk want to hear at the moment when it comes to bubblicious equity prices and the speculative trades currently dominating the pages of the financial press. The market’s dirty little secret is it’s been ultra-low bond rates that have been fuelling market madness, making nonsensical concepts look like financial genius on a “relative basis” to negative yields. If bond yields were to rise, it won’t just be bond holders that suffer.
The second issue is that since the Global Financial Crisis 2007/31 began, central banks have been manipulating bond yields, compromising that fundamental truth of bond yields. When bond yields are no longer set by the market, but by the QE policies of central bans, then There Will Be Consequences…. I fear these are upon us!
The immediate threat receded when yesterday’s 10-year auction did better than expected – firming up around 1.13%. That’s still well above the 1% threshold we though were sacrosanct about a thousand years ago on Jan 1st 2021. The real yield of the US 10-year bond – its notional yield less inflation – is still deeply negative around -ve 0.90%! Who wants to own bonds that cost nearly 1% in real returns?
Well… lots of people apparently do – or maybe did. This year we’ve already seen a slew of European sovereigns drop new negative yield bonds into the market. The ECB will be hitting the market with more of its rescue fund bonds to prop up ailing Covid ravaged economies. Over $18 trillion of global debt now trades with notional negative yields! And folk keep buying them – mainly because central banks like the ECB and The BOJ have promised to keep lapping them up. There is talk about the Bank of England finally going down the negative yield route because of the dire state of the economy – which would mean UK Gilts should rally.
The US 10-year bond yield was over 3% back in Nov 2018. Since then it rallied hard on the back of trade war slowdown, Trump demanding the Fed caved into his demands to juice the economy, and then the Pandemic. A 2% change in yields might not sound much, but the mathematics of bonds mean that a drop from 3% to 1% in yield creates a spectacular return for bond holders.
(One day I will get round to writing an article on bond maths (US readers – note, its maths, not math), but at the moment life is too short to squander… (Adrian J… you’re bored.. fancy writing it for me?)
Low bond yields have enormous consequences. They make bonds look less attractive from a return perspective – therefore other assets look more attractive. That rally in bonds has driven much of the relative value rally in stocks. Smart investors have ridden yields lower, and have piled their profits into higher-risk equities in search of relatively higher returns – so the conventional wisdom says.
But now… .after 2 years of bond rally, it’s clear bond yields – which rallied all through the Pandemic year – have now turned. Oh dear.. that sounds rather like inflection point.. Rising rates would makes sense to investors – they all expect the global economy to recover post pandemic, they fear all the government aid, support and unrestrained money printing will create real inflation, and therefore bond yields will/must rise.
Rising rates would hit the wisdom of low rates driving the equity rally: as long as equity prices continue to post startling returns (fuelled by low rates) then all is well and good. But if bond yields were to rise…. Then the equation starts to change.
As I wrote yesterday, its highly unlikely we will actually see yields rise by any significant amount… In the US, the new Biden presidency is expected to stimulate the economy. Central Banks will not contemplate tightening in the devasted post-Covid economic landscape… the economic strength of the Covid-ravaged global economy is too perilous, rising rates would hold back investment, etc…. but I suspect their real fear is a market collapse. As the Taper Tantrum way back in 2013 demonstrated (when the Fed tried to undo the supports given to markets after the 2008 global financial crisis) markets will go into meltdown at any sign of rates being normalised.
A market collapse would not just be the optics of falling stock market valuations. It would have very real consequences on individual savings and pensions, on banks, on the flow of the economy and, as we saw in 2007/08, create very real economic misery in terms of employment and growth. Its politically unacceptable.
The threat of higher yields will no doubt trigger further Fed action to continue to “average down” rates via bond buying QE programmes. The danger is such market intervention, manipulation or even repression – depending on your political stance to markets – has its own consequences. These have been piling on top of each other since 2008.
One of the Big Questions in markets at the moment is the adoption of Bitcoin. The fanboy shysters say Bitcoin has now been widely adopted and accepted as better than gold, and that’s why it’s rising. The nay-sayers look at the volatility and say it’s a speculative bubble…
I suspect a big issue behind sensible, serious investors actually taking time to even consider Bitcoin is the as yet unfelt consequences of the QE repression of real interest rates.
Bitcoin was founded in financially illiterate libertarian mumbo-jumbo about how fiat money is controlled by pernicious governments. The bitcoin touts say their money is better than Govt money: “why trust government and take the risk of fiat money when governments are abusing their position as monopoly money suppliers by devaluing currencies through unrestricted money printing and negative yields..” Terrrible! Shocking! they say… “Trust us instead… Give us your money in exchange for these
magic beans imaginary coins.. sure you can trust us and our imaginary invisible currency that only exists on an ethereal platform we say exists…”
Sure.. makes sense to me… NOT! If the consequence of these many years of QE is Bitcoin.. then we really are in trouble.
Bitcoin is just one of many speculative bubbles feeding off the detritus and consequences of QE and monetary yield repression. Which is why I’m staying long on gold for the time being…
Five Things To Read Today
Out of time, and racing to my Zoom call…