PIMCO Scott Mather has released a fascinating Q&A in which the key topic of discussion is the artificial push to keep rates low in developed economies, also known as central bank hubris to maintain the "great moderation" in which he clearly explains i) what this means for global fund flow dynamics (using developed country reserves and purchasing EM bonds) and ii) for the future of a system held together with glue and crutches. To wit: "Financial repression is any public policy that is designed to influence the market price of financing government debts, either through government bonds or the nation’s currency. Direct methods of repression include things like setting target interest rates, monetizing government debt or implementing interest rate caps. Indirect methods include polices designed to change the amount of debt or currency at a given price. Examples include requirements to hold minimum amounts of government debt on bank balance sheets or establishing minimum requirements for government bonds in pension funds." Just in case anyone is confused why central planning is a bad idea: "Governments may take these steps to improve their ability to finance public debt and forestall more painful adjustment processes, though there can be other motives, and because these methods are less transparent, and thus less controversial, than direct tax hikes or spending cuts. Investors should be wary of financial repression because it is primarily a tool to redistribute wealth from creditors (citizens) to debtors (governments) to the detriment of creditors, fixed income investors and savers." Needless to say, central planning always fails: "It is important to realize these methods as practiced are only partially effective and cannot go on forever, as advanced economies continue to add significantly to their public debts despite low financing costs. Some intensification of financial repression, fiscal austerity, or stronger growth must occur to lower the likelihood of a future debt crisis." Bottom line: "kicking the can" can only go on for so long before EMs (read why below) provide a natural counterbalance to an artificial market created by developed world central banks. PIMCO's advice: get out of balance sheet risky DM bonds ahead of central planning failure, and buy up every EM bond possible, or bypass paper and just buy EM currencies as "EM policymakers who have resisted appreciation will eventually allow more appreciation over the next three to five years as they nurture domestic consumption and their economies become less dependent on export demand." We expect to see much more on this topic as the MSM realizes the implications of this new risk regime change.
Game Change for Bond Investors?
- Over the next three to five years, we argue that market behavior may be vastly different than what typical cyclical models would predict.
- Sovereign debt, which is at the core of our global financial system, is undergoing a seismic shift.
- Governments practicing financial repression may be transferring wealth from creditors (citizens) to debtors (governments) to the detriment of creditors, fixed income investors and savers
Q. There seems to be a great deal of uncertainty about the outlook for bonds. What would you suggest investors consider first?