Authored by Bill Blain of Mint Partners,
These are not easy times for the global bond market. We’re looking at US Treasuries market (more below), and reckon this morning’s 10-yr spike to 2.23 is only the start. We could see more aggressive price declines as the curve steepens further. It’s only partly based on the better economic outlook and fears of the QE Taper. Japan banks will be among the biggest sellers due to the volatility and “death by carry”. Forget the stories Japan banks were buyers at the wides.. that’s wishful thinking from Treasury holders long and wrong on the US bond market.
Meanwhile, my Tech Chart Expert, Graham Joy points out some interesting data – “Dow 20 for 20 Turbo Tuesdays: up 11% on the year, but without Tuesdays would be only 0.2%!.. 20 Tuesdays in a row since Jan 25th!
But start in Japan where tensions are building. The Kuroda plan is failing to reign in JGBs - increasing bond volatility and weak demand for the latest 20-yr auction illustrate the widening credibility gap between what the BOJ expected and what’s actually happening! JGB futures vol is now highest since 2008.
What's required to calm the JGB market? Unfortunately, each passing day sees the BoJ's credibility chipped away. Far from lowering Japan rates, many analysts now believe the massive Kuroda QE ease was a desperate play likely to backfire, resulting in unsustainable interest rates. Kyle Bass in the ascendency! It’s a vicious negative feedback loop.
Step back a second. Yes, the plan does appear to have stalled, but what plan ever survives first contact with the enemy? That’s part of the problem – even a good plan could wither if exogenous forces, like a Treasury sell off, make it meaningless. After telling us how lower JGB rates were vital to the plan, Kuroda does not sound nearly so convincing when he's telling us the financial system can weather higher yields alongside an economic recovery! The FX boosted export recovery is highly vulnerable to reversal or at best slow down in the face of other countries competitively devaluing.
On the other hand, the reason Japan got away with the massive devaluation of the yen was the complicit support of China and US within G20 to ensure it was accepted as the most likely driver of global growth. I doubt other economies will get similar breaks. Remember the key market mantras: "Don't fight Central Banks" and more recently "Don't fight Kuroda". But.... if you see the Yen start a steady recovery, (fuelled by the more attractive rates), that’s the point to consolidate or even advance in a rearwards direction on Japan.
Back to the US. Rising home prices trigger further fears of an early taper to the mortgage part of QE. Take a look at expectations for US futures and they show the market anticipates rising rates. Can't fight what the market is telling you! Over the next couple of weeks I expect the market scribblers will play catch up – watch for the increased US economic estimates. Last year I took a bit of a flyer and blythely said US growth could be a surprising 3% plus by year end - despite the recent negativity and mixed noises off, I still think its achievable!
It all spells further rates sell off – and all the implications for other frothy asset bubbles. Rising US rates really will trigger a global bond bear market, so some advice for European banks still long of distressed assets held on "pretend and extend" banking books. (i.e. distressed European lending marked at par in the hope the global and European economies will recover sufficiently these assets will repay at 100.) Take a look at what Lloyds is doing.
Lloyds is auctioning its US$8.7 bln mortgage portfolio - smart move! WIth the market fearing the Fed may hold back on supporting US mortgage paper... then selling what used to be distressed product now makes sense... And remember, Lloyds is the UK bank with the good sense to take the pain when it could - selling off its Irish mortgage book and large chunks of distressed UK Commercial Mortgages. Sure it took the capital hit, but now looks significantly stronger institution.
How many other European banks should be considering similar "distressed asset sales"? Well this is the time to be doing it! We are in touch with a number of investment funds who are active acquirors of distressed assets. Too many European banks are still sitting on Spanish mortgage exposure (it’s going to get worse), European SMEs (its going to get worse), securitisations (they are going to get worse), etc etc.. Forget the asset class, and think about yesterday’s miserable French consumer sentiment – yep.. Europe is going to get worse!
But why sell distressed assets now? After all, wont the ECB backstop everything to prevent renewed Euro fears. We've seen the mother of benchmark distressed assets, Greece, trade up all the way from 20% to 8%. CFO's overseeing the distressed books must feel vindicated for not selling at the bottom of the market, and seeing values recover close to par in many instances. Well done.
But the next step is the difficult one - knowing when to sell. I reckon that point has come: we've seen sustained bond market gains and pretty much exhausted further upside. From here on in the risks are about deepening European recession eroding gains thus far.
Finally.... reading a predictable Torygraph rant this morning about how Portugal is likely to exit the Euro, the comment was made about Ireland's export led recovery. Bearing in mind the current unpleasantness directed at the Emerald Isle over its’ corporate tax rates and the fact all the major multinationals from Google, Mac, Amazon etc route all their profits through Ireland, thus dramatically "improving" the official numbers, I'd be grateful if anyone has seen any research on just how much the Irish economic recovery is a tax-driven sham? How much GDP has been distorted relative to what's actually made in Ireland? And how complicit has the government been in this illusion of robust Irish growth?