Bill Blain: "Something Is Happening In Europe And We Don’t Know What It Is…"

We start with the overnight observations by Mint's Bill Blain who points out something contradictory: on one hand Europe is said to be "fixed" with inflation expectations rising and the ECB preparing to take its foot off the gas pedal. On the other hand, "European Sovereigns will start issuing long bonds again.... A French 30yr is in the works, Italy and Belgium are both looking, while other rumours say the EFSF might be in the frame. ... Long dated low yield bonds make great sense when inflationary expectations are low into infinity, and you expect the New Normal of Low Rates in perpetuity to hold for ever."

As he puts it, " If the global economy is so rosy, why is the Euro bond market going long? Whatever happened to expectations Europe was going to grow again?  Something is happening and we don’t know what it is…"

Perhaps what is going on is that the market is looking beyond the current "reflation" scare, and already preparing for the next deflationary downturn, now that China's credit impulse has fizzled and the impact is set to hit the world in the coming months...

In any case, read on from Blain’s Morning Porridge – May 11th 2017

America? Huh... and why European bond bond boom spells trouble

 

“So you can wipe off that grin, I know where you’ve been. It’s all been a pack of lies….” 

 

A number of readers took me to task y’day for not making Trump’s “Your Fired” FBI moment the core story of the day. Perhaps I should have – adding what to the sum of human confusion? 

 

While some commentators think it opens a whole new American Can of Worms, I reckon it’s just more of the same. Get over it. That a US president dispenses with an awkward agency head is not unique. Will the truth about Trump, Mike Flynn and Russia ever emerge? Some of it will – revealing, yes! they’d been talking, but… as long as those photos from Moscow never emerge (what photos?) it will all be fine… 

 

A resumption of Trump dramatics provides some unhealthy distraction from the main event – the bright global reflation trade looking increasingly tarnished. It’s opened the box for the Democrats to get “holier than thou” and the Republicans to accuse them of hypocrisy.. Oh, the irony, the irony. 

 

I did spot one interesting note in the news – apparently the Senate Intelligence Committee (how busy can that body ever be?) has requested information on Trump from FinCEN – the US agency monitoring money laundering. (Same crowd fined Trump Taj Mahal $10mm in 2015 for multiple violations – which was sometime after Trump himself ceased to be involved.) Have Putin’s cronies been investing in Trump real estate is apparently the question FinCEN is asking.  

 

Back to the main story – the same one I’ve been harking on about for months: risks to the global feel-good.

 

I’m worried – too many people think things look too good. One of my favourite stockpickers told me he’s “never seen such strong fundamentals”, while another bond manager says he can’t get allocations increased on his credit plays because they’re bullish stocks. My Japan watchers tell me the reason the Nikkei has rallied is a turnaround in Global investors getting positive on Japan again.

Yet, there is plenty of contradictory bluster out there: 

 

In an excellent comment from my chum Marcus Ashworth (a Bloomberg Gadfly), he notes the market in European Long Bonds is about to explode. 

 

There has been precious little demand for the long end duration risk in the Euro bond market in recent months.The Italy 50-yr 2.8% of 2067 traded down from 100 in October ’16 to 83.00 now! That’s a 75 bp widening in yield, confirming bond-buying folk were concerned about Euro stability, inflationary pick up, and the political risks pre Macron’s coronation last weekend. 

 

Ashworth says the landscape has changed – and even as bond issuance falls, European Sovereigns will start issuing long bonds again. Long dated low yield bonds make great sense when inflationary expectations are low into infinity, and you expect the New Normal of Low Rates in perpetuity to hold for ever. (And only buy Long Bonds when the yield curve is steep enough to justify conditions 1 and 2!) 

 

A French 30yr is in the works, Italy and Belgium are both looking, while other rumours say the EFSF might be in the frame. Fascinating stuff, but with the ECB already taking the metal off the QE pedal, what happens when the market distortion stops? Where do bond prices go when the ECB stops buying, and, heaven forbids, starts to “normalise” the balance sheet by selling its quintillion bond holdings

 

If the global economy is so rosy, why is the Euro bond market going long? Whatever happened to expectations Europe was going to grow again? 

 

Something is happening and we don’t know what it is…but if you fancy the long end of the Euro market.. you know my number..