Blain’s Morning Porridge – March 8th 2023: International Women’s Day and The Conundrum at the Heart of the Bond Market..
“Women of the world take over, If you don’t the world will come to an end..”
This morning – Make the world a better place by enabling women on International Women’s Day! And, Bond Markets need to a rethink.
Women of the World unite! Its International Women’s Day! (If I don’t say something positive She-Who-Is-Mrs-Blain and young Ms-Blain will “chastise” the living daylights out of me!)
UK child-care costs are the highest on the planet. As a result we squander some of the best minds and skill sets because families can’t get child-care at affordable prices. Its women who generally give up their careers to care for the kids. They could have been changing the future path of the economy, but see their careers and gifts to society squandered. 100 years after the suffragettes its extraordinary we are still not enabling women to fulfil their economic potential! We’d be far better investing in free child-care than in practically any other policy to drive the economy.
Sir Kier – are you listening? (Because the Tories won’t be…)
Recently I read Max Hastings excellent book Abyss about the Cuba Missile Crisis. I don’t remember it well – I was in my pram at the time, but my mum told me how terrified she was. What is really, really scary is just how willing some in the US military – especially certain Air Force officers – were to go to a full war. Reading through some of the recent scary stuff on US wires and periodicals, its clear there is an increasingly hawkish mood re the “inevitability” of War with China.
I can’t help but think of August 1914. If only some woman had been able to interrupt the slide towards war… and tell the boys to stop their stupid squabbling… Maybe that’s a porridge for another day….
Meanwhile… back in the markets…
Fed Head Jerome Powell is warning of rate hikes still to come. Front pages tell us Blackrock and others now think the US Fed Funds rate could go to 6%. (Blackrock’s CIO said: “the Fed will have to bring the Funds rate to 6% and keep it there for an extended period to slow the economy and get inflation down to near 2%.”) I read some bank research saying an ongoing series of multiple 25 bp hikes is potentially on the cards till the economy cracks. Yesterday US 2-years T-Bills went over 5%. Yet….
I read a remarkable note yesterday suggesting rising US treasury yields means US bonds are a screaming buy…. on the basis they will come down again. Meanwhile, yield curve inversion – which traditionally signals a recession around the corner – is back at elevated levels.
It’s fascinating how market participants now think about bonds, inflation and interest rates. 14 years of monetary experimentation and ulta-low rate distortions has changed the fundamentals of bond market behaviour.
Back in the day, I learnt – the hard way – that bond yields could respond aggressively to inflation, currency moves and economic inputs. In order to achieve price stability, Central Banks would not hesitate to hoik rates aggressively. Policy changed during the Global Financial Crisis of 2008 as the fragility of the global financial system was exposed. Perhaps central banks were over- protective – ignoring the fundamental right of the capitalist system is the right to fail. It’s a learning experience….
The failure of Lehman Brothers scared the central banks, and they concluded such failure was just too perilous and consequential. Central banks acted to stabilise rates at ultra-low levels in order to boost post-crisis recovery – but it all became about the stabilisation of markets.
That was maybe, with the benefit of hindsight, an even bigger mistake. It enabled the tail to wag the dog!
QE and ZIRP (quantitative easing and Zero Interest Rate Policy) boosted markets. The consequences – which I have written about so many times – were immediate: the massive inflation of financial assets. It’s the major reason equity prices have risen 7 times faster than the underlying global economy has grown since 2008.
Today’s bond traders have known little else but market friendly easy money, central bank puts and 2% inflation targets. They persuaded themselves negative interest rates made sense and were investible. Bond market psychology clearly changed. It has to change again – and relearn some fundamentals.
Conventional wisdom holds the current yield curve inversion is pointing towards an “apocalyptic” depression is coming, but the reality is a very strong labour market, and an economy set to make significant productivity gains as wave 4 of the tech revolution (AI) sweeps over the economy. The bond market is now scaring itself – again – about further rate hikes triggering a crash landing.
However, there is another perspective to take, and that’s the structure of the bond investment market. Factor that into you bond assessement. The market remains distorted.
Regulations and investment mandates mean most big funds are forced to invest in bonds to meet their future liabilities, pass tick box regulatory checks, and demonstrate to their savers/investors they are buying all the right CSR/ESG etc etc instruments because they are beating the indices. Meanwhile they have to balance the equity risks on their portfolios vs the risk-free rates notionally contained in their government bond portfolios.
One of my colleagues was at a meeting with a major bond investor yesterday. Being an equity guy he asked a simple question.. (bond guys tend not to ask simple questions for fear of being thought of as simple equity guys). He asked: Why aren’t you buying higher yielding short-dated bonds instead of the long-dated bonds you are buying? If you buy the “long-end” you miss a “free-lunch” for buying higher yielding shorter dated bonds..
The answer is simple – it’s the “mandate stupid.”
Effectively the rules mean the big investors have to buy long dated bonds, and they need to keep buying more and more of them to put their cash to work in an investment world where there is no shortage of liquidity, but still a massive scarcity of investible opportunities at prices that match their relative risk… And they keep buying the long end even though it makes little sense because the indices they have to beat are composed of these long-end assets.
The reality is.. as it so often is in markets.. the big beasts consume themselves, while the smarter more nimble fund managers can thrive…
No time for five things this morning…
Out of time and back to the day job…
Strategist – Shard Capital