"While we are not likely to see a repeat of that type of [30Y bond] bull market any time soon, we also do not believe we are at the beginning of a bear market for bonds."
"We are concerned by the growing downside of zero-based money and QE policies – among them a worrisome distortion in asset pricing, the misallocation of capital and ultimately a dis-incentivizing of risk taking by corporations and investors."
"We believe caution is warranted not just for fixed income investors, but for investors in all risk assets; avoiding long durations, reducing credit risk away from economically vulnerable companies and sectors"
"I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.... The accident -- the fiscal train wreck -- is already under way.... How will the train wreck play itself out? Maybe a future administration will use butterfly ballots to disenfranchise retirees, making it possible to slash Social Security and Medicare. Or maybe a repentant Rush Limbaugh will lead the drive to raise taxes on the rich. But my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.... And as that temptation becomes obvious, interest rates will soar. It won't happen right away. With the economy stalling and the stock market plunging, short-term rates are probably headed down, not up, in the next few months, and mortgage rates may not have hit bottom yet. But unless we slide into Japanese-style deflation, there are much higher interest rates in our future.... I think that the main thing keeping long-term interest rates low right now is cognitive dissonance."
It’s always a bit amusing to meet an investor making money in the markets right now who actually thinks it’s because he’s smarter than everyone else. Everyone knows the Fed’s quantitative easing program calls for them to buy $85 billion worth of bonds and mortgage backed securities each and every month. And the connection to market performance is clear. But, as is clear with USDJPY, Nikkei, and European sovereigns, the end of this exuberance is beginning to happen. All of this indicates that the leveraged investing herd seems to be squaring positions, going to cash, and paying back some of the USD-denominated debt they’ve borrowed. So far it’s all been an orderly move lower. And herein lies the trouble. Few investors are spooked right now because there is so much calm in the markets. But that calm can quickly turn into anxiety, which can quicly turn into all-out panic. It’s taken years (since 2008) to print so much money. This means that a market panic will unwind years’ worth of liquidity in a matter of weeks. It’s a financial tsunami that no investor should underestimate.
By now it is conventional wisdom that the Italian economy is foundering alongside all other peripheral European nations as a result of a failed artificial currency leading to an inability for external rebalancing, a flawed monetary system leading to a collapse in credit demand, and the lack of any structural reform (and sorry, but when your budget deficit is soaring alongside your debt it's anything but "austerity's fault"). However, there is hope. According to Italy's trade union CGIL, good news may be just around the corner as Italy looks set to recover its pre-crisis unemployment level... In 2076, or a brief 63 years from now. "So, you're telling me there's a chance."
In the 15th century, the highest standard of living in the world belonged to China. Places like Nanjing had reached the pinnacle of civilization with incredibly modern infrastructure, robust economies, substantial international trade, great healthcare, and a rising middle class. If you had told a Chinese merchant at the time that, over the course of the next several hundred years, global primacy would shift to Europe (and a relatively unknown American continent), you would have been laughed at. It was simply unthinkable given how advanced China was over the west. And yet, it happened. Ironically, the tables are turning yet again; in total objectivity, the patient is beyond cure at this point… and the math is quite simple. Nations typically enter this vicious cycle once they start having to borrow money just to pay interest on what they already owe. The US is already way past this point.
The US currency is shrinking as a percentage of world currency today according to the International Monetary Fund. It’s still in pole position for the moment, but business transactions are showing that companies around the world are today ready and willing to make the move to do business in other currencies.
Following yesterday's blow out in US bond yields, which have continued to leak wider and are now at 2.20% after touching 2.23%, the overnight Japanese trading session was relatively tame, with the 10Y JGB closing just modestly wider at 0.93%, following the market stabilization due to a substantial JPY1 trillion JOMO operation which also meant barely any change to the NKY225, while the USDJPY slipped in overnight trading below the 102 support line and was trading in the mid 101s as of this moment, pulling all risk classes lower with it. There was no immediate catalyst for the sharp slide around 3am Eastern, although there was the usual plethora of weak economic data.
Spanish economic data does not always pass the sniff test. A simple example that JPMorgan's Michael Cembalest explains is that as unemployment rose from 10% to 25% from 2008 to Q2 2012, Spanish banks reported stable non-performing loans of 3%. The latest Mad-riddle, as he calls it, has to do with corporate profits but recent headlines from PM Rajoy, explaining his approach to solving the country's devastating youth unemployment problem just beggars belief. Simply put, as Bloomberg reports, he proposes to create a mechanism to temporarily exclude tax rebates granted to companies for hiring young people from the calculation of the government budget deficit - which, his twisted logic prompts, "would enable immediate action because we’d lower contributions to the Social Security system and this would facilitate and encourage hiring. So in summary, his suggestion to boost youth employment is... to further misreport the deficit and to underfund social security even more. With Spanish data already questionable (as we discuss below), this simply exaggerates an already farcical situation.
Spanish and Italian stocks are up 3% this week, European sovereign bond spreads are compressing like there's no tomorrow, and Europe's VIX is dropping rapidly. Why? Aside from being a 'Tuesday, we suspect two reasons. First, Hungary's decision to cut rates this morning is the 15th central bank rate cut in May so far which appears to be providing a very visible hand lift to risk assets globally (especially the most junky)' and second, Spain's deficit missed expectations this morning (surprise), worsening still from 2012 and looking set for a significant miss versus both EU expectations (and the phantasm of EU Treaty requirements). As the following chart shows, Spain is not Greece, it is considerably worse, and the worse it gets the closer the market believes we get to Draghi firing his albeit somewhat impotent OMT bazooka and reversing the ECB's balance sheet drag. Of course, direct monetization is all but present via the ECB collateral route and now the chatter is that ABS will see haircuts slashed to keep the spice flowing. What could possibly go wrong?
What is the outlook for Fed policy? Can Japanese officials stabilize the bond market? Is the ECB going to adopt a negative deposit rate? What are the latest inflation readings? Is the soft landing still intact for China?
In the 1940s, the Fed adopted pegging operations to protect the financial system against rising interest rates and to ensure the smooth financing of the war effort. In effect, the Fed became part of the Treasury’s debt management team; as the budget deficit hit 25% of GDP in WW2, it capped 1Y notes at 87.5bps and 30Y bonds at 2.5%. From the massive bond holdings of its domestic banks to its exploding public debt, Japan today faces a situation very similar to the US in the 1940s. When the long-term rate climbs above 2%, the BoJ will probably adopt outright measures to underpin JGB prices to prevent turmoil in the financial system and a fiscal crisis - and just as Kyle Bass noted yesterday, they are going to need a bigger boat as direct financial repression in Japan is unavoidable.
What may come as a surprise to most, is that as of this week's H.4.1 update, the amount of ten-year equivalents held by the Fed increased to $1.583 trillion from $1.576 trillion in the prior week, which reduces the amount available to the private sector to $3.637 trillion from $3.668 trillion in the prior week. And also, thanks to maturities, and purchase by the Fed from the secondary market, there were $5.219 trillion ten-year equivalents outstanding, down from $5.244 trillion in the prior week. What this means simply is that as of this moment, the Fed has, in its possession, a record 30.32% of all outstanding ten year equivalents, or said in plain English: duration-adjusted government bonds. It also means that the amount of bonds left in the hands of the private sector has dropped to a record low 69.68% from 69.95% in the prior week. Finally, the above means that with every passing week, the Fed's creeping takeover of the US bond market absorbs just under 0.3% of all TSY bonds outstanding: a pace which means the Fed will own 45% of all in 2014, 60% in 2015, 75% in 2016 and 90% or so by the end of 2017 (and ifthe US budget deficit is indeed contracting, these targets will be hit far sooner). By the end of 2018 there would be no privately held US treasury paper.
Preview of tomorrow's Bernanke testimony and FOMC minutes.
My guess is that in 2-3 years most folks in the country are going to hate Obamacare, but it it will be impossible to get rid of by then.
On one hand we have bad Hilsenrath sending mixed messages saying the Fed may taper sooner (with good Hilsenrath chiming in days later, adding it may be later after all), depending on whether HY bonds hit 4% YTM by EOD or mid next week at the latest. On the other, even resolute Fed doves are whispering that a tapering may occur as soon the summer, so in a few months, and halt QE by year end. Bottom line - confusion. So who better to arbitrate than the firm that runs it all, Goldman Sachs, and its chief economist Jan Hatzius, who issues the following Q&A on "tapering." His view: "not yet." Then again, Goldman is the consummate (ab)user of dodecatuple reverse psychology, so if Goldman says "all clear" the natural response should be just as clear.