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"Neither Central Bankers Nor Market Participants Can Extract Any Information From Current Bond Valuations"

Tyler Durden's picture




 

Via Scotiabank's Guy Haselmann,

All is not what it seems. Markets are upside down. Some ‘risk?free’ assets can be purchased for a guaranteed loss. EU asset markets (ex?Greece) are soaring at the same time that EU disunity is rising. An interest rate hike by the Fed is likely to cause a rally in Treasury bonds and a steep correction in US equities.

Unlike in years past, neither central bankers nor market participants can extract any information from current bond valuations. Despite high debt and deficits, regulations and central bank QE programs have caused demand for sovereign bonds to surpass supply. The combination of forced purchasers of securities and the distorted price of money (interest rates) makes it a futile exercise to forecast bond yields base off the economic fundamentals.

In a normal market environment, yields would typically rise if a major central bank was able to successfully increase growth and inflation. Today, an increase in yields would probably not be viewed as an indication of success for a central bank, since higher yields might accompany negative consequences: such as, lending issues in the EU, housing headwinds in US, and debt servicing troubles in Japan.

  • In this light, the ECB QE program was designed to buy twice the amount of net issuance across the Eurozone. However, driving yields down and risk asset up has its own set of consequences. For this reason, I stand by my February statement that the program will end prior to the estimated end date of September 2016.

The ECB and ESRB (European Systemic Risk Board), for instance, may already be worried about the impact of the QE program in the midst of the aggressive regulatory environment. Today’s report by the ESRB entitled “ESRB Report on the Regulatory Treatment of Sovereign Exposures”, recognizes the “significant amounts of risks to financial institutions stemming from their holdings of sovereign exposures”.

  • Basically, the report admits that regulations may have led banks to counter?productively invest too much in their own sovereign bonds. The report is 222 pages long, but a clear outline of their worries can be gleaned by reading the Executive Summary and Introduction sections (pages 6?12).

As Reuters reported today, Draghi fully recognizes the difficulty of reforming the existing regulatory framework without rocking sovereign debt markets. Nonetheless, a full review is likely. In the meantime, core EU bonds should continue to be pulled down to 0.0% as hoarding and demand stays high. Yet, the negative 0.20% cap may be a level too disruptive to achieve before something cracks.

Currently, there are QE?eligible negative?yielding bonds in Germany, France, Finland, Belgium, Austria, Slovakia and the Netherlands. Over time, having too many bonds trading at negative yields could result in destabilizing capital flows and unstable markets.

Some banks and insurance companies may not be willing sellers even at deeper negative yields due to accounting aspects and their reinvestment risk. As bonds decline into negative territory, the negative second order effects could get the ECB to end its QE program early. Softening of the regulatory rules is unlikely; but should such changes occur, an ugly bond market sell?off would result.

  • Note: some believe that paying money to lend to governments is a sign of Japanese?like economic stagnation, but it is more likely due to the regulatory and QE effects mentioned above.

It is interesting that yields are falling and spreads converging in the Eurozone concurrent with what appears to be budding EU disunity. There have been dissents or differences in regards to the handling of Greece, Ukraine, budgets, and ECB QE. Even more important, however, is the fact that the strict budget rules adopted under the ‘Growth and Stability Pact’ have unravelled with yet another reprieve to Italy and France’s deficit violations. The frequent changing of the rules and deadlines is not good for the credibility of the system

Despite significant (non?Greek) periphery spread tightening, a Greek default is looking more likely with each passing day. An exit would set the precedence that a country can leave the Eurozone. The dramatic risk in Greek yields this week should be an indication that the powerful convergence trade of other sovereign is not a one?way bet.

Nonetheless, the stampede into core European bonds may continue for a while longer. However, it’s wise to remember that as more bonds plunge into negative yields, their risks push farther away from ‘risk?free’ status.

Markets will increase their probability of a June Fed hike when the FOMC removes the word “patience” from its statement on March 18th. This should add to the momentum behind USD strength which in turn is bad for US stocks, the EURO, and Emerging Markets. It is also disinflationary. I prefer exposures to US Treasuries over EU debt, and I stand by my comment from March 5th that the S&P will trade sub 2000 before the March 18th FOMC meeting. I still expect the US 10?year Treasury to trade sub 2.00% by the end of the month and to make a new low in 2015 (below 1.65%).

“OK. Just a little pin prick. There’ll be no more – Aaaaaahhhhh! But you may feel a little sick.” – Pink Floyd

 

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Wed, 03/11/2015 - 09:51 | 5877190 Moski
Moski's picture

I know it's early but the typos in the several ZH articles this morning are disrupting my enjoyment of them.

Wed, 03/11/2015 - 09:56 | 5877204 El Oregonian
El Oregonian's picture

eh, "To error is human, to complain over petty crap is OCD". In other words, go pee in someone else's backyard.

Wed, 03/11/2015 - 10:07 | 5877245 Moski
Moski's picture

There's an entire industry devoted to that "petty crap" in writing.  It's not pendantry to let ZH's editors know to up their game.  

 

Wed, 03/11/2015 - 10:26 | 5877331 Enceladus
Enceladus's picture

ZH didn't write it

Wed, 03/11/2015 - 10:41 | 5877390 bwh1214
bwh1214's picture

Pretty obvious the bond market is broken, these are some great explainations of things we all need to know.

http://www.debtcrash.report/entry/i-bought-what

 

http://www.debtcrash.report/entry/debt-taken-on-by-fools

Wed, 03/11/2015 - 10:13 | 5877200 Ghordius
Ghordius's picture

I never feel as good about the EUR as when a Scotiabank director moans about it

right you are, Mr. Guy Haselmann! stay away from all things beginning with eur! and thanks for those two nuggets:

"As bonds decline into negative territory, the negative second order effects could get the ECB to end its QE program early " That would be baaad, would it?

"Nonetheless, the stampede into core European bonds may continue for a while longer"

Wed, 03/11/2015 - 10:49 | 5877423 Money_for_Nothing
Money_for_Nothing's picture

If FDR was alive and was ruler of the EURO he would confiscate all bonds from the hoarders and build a vault in Germany to put them in.

Wed, 03/11/2015 - 11:29 | 5877618 max2205
max2205's picture

Silver coffee oil utilities and Apple are on sale today....Fuck bonds!

Wed, 03/11/2015 - 09:54 | 5877201 Philo Beddoe
Philo Beddoe's picture

I actually told my silver stack to Fuck Off last night, 

Wed, 03/11/2015 - 09:58 | 5877212 NoDebt
NoDebt's picture

You're gonna get some down votes for that comment, but I don't care.  That's funny.

Wed, 03/11/2015 - 09:54 | 5877203 surf0766
surf0766's picture

Increasing rates in the us will cause inflation

Wed, 03/11/2015 - 10:04 | 5877237 venturen
venturen's picture

 

what signs are left to prove we are in a great depressions. The only thing left is the great dump....Gold, metals, commodities, NIRP are all screaming DEPRESSION....who wants to bet the stock market is down 50% in 5 years?

Wed, 03/11/2015 - 10:30 | 5877355 Crisismode
Crisismode's picture

 

 

who wants to bet the stock market is down 75% in 5 years?

 

There, fixed it for you . . .

 

Wed, 03/11/2015 - 10:32 | 5877356 venturen
venturen's picture

now don't be silly...

Wed, 03/11/2015 - 11:05 | 5877505 dimwitted economist
dimwitted economist's picture

the Fucking stock market should be down a LOT more than 50% and it will be SOONER than many will believe!

Wed, 03/11/2015 - 14:20 | 5878471 lordkoos
lordkoos's picture

If interest rates go up gold is definitely going down...

Wed, 03/11/2015 - 10:18 | 5877289 Racer
Racer's picture

Paying money to lend is insane

Wed, 03/11/2015 - 10:19 | 5877300 Kina
Kina's picture

Typos reminds me this isn't MSM produced crap...but real people who know what they are about and not editors.

Wed, 03/11/2015 - 10:27 | 5877335 JRobby
JRobby's picture

Chaos in the bond markets?

Uncertain valuations?

How surprising after 6 1/2 years of NIRP / record issuance??

Wed, 03/11/2015 - 10:34 | 5877365 unemployed
unemployed's picture

"An interest rate hike by the Fed is likely to cause a rally in Treasury bonds"   You are forecasting long term Bond rates are going to continue to go down?   Hello,  the end of QE in 2015 means the Fed stops buying as much of those bonds and with less demand the rates are going up.   But talk of QE is smoke and mirrors anyways,  the Fed stopped driving the bus in 2009  and just bailouts mortgage security holders and be the bag boy for long term Treasuries.

Wed, 03/11/2015 - 10:59 | 5877477 alangreedspank
alangreedspank's picture

I thought that was odd too. But perhaps if, if the Fed hike a full point it will attract investors simply for the yield... Who knows.

Wed, 03/11/2015 - 12:18 | 5877494 skbull44
skbull44's picture

Some more Pink Floyd:

And when you lose control, you'll reap the harvest you have sown.
And as the fear grows, the bad blood slows and turns to stone.
And it's too late to lose the weight you used to need to throw around.
So have a good drown, as you go down, all alone,
Dragged down by the stone.

I gotta admit that I'm a little bit confused.
Sometimes it seems to me as if I'm just being used...

http://olduvai.ca

Wed, 03/11/2015 - 15:25 | 5878762 JRobby
JRobby's picture

And after a while, you can work on points for style
Like the club tie and the firm handshake
A certain look in the eye, an easy smile
You have to be trusted by the people that you lie to
So that when they turn their backs on you
You'll get the chance to put the knife in

Read more: Pink Floyd - Dogs Lyrics | MetroLyrics
Wed, 03/11/2015 - 11:13 | 5877541 bnbdnb
bnbdnb's picture

Anyone else ever wonder what inflation would look like if we didnt have technology(automations, bio-engineering, etc) to surpress it?

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