Blain: "The Bond Market Has Become A Series Of Crashes Followed By Rallies"

Submitted by Bill Blain of Mint Partners

Blain’s Morning Porridge - Why Bond markets are going down and Markets have no memory

“And everything around her is a silver pool of light, the people who surround her feel the benefit of it. It makes you calm...”

Before delving into the collapse in global bonds on tightening speak, the improving prospects for real policy drivers and tax-cuts out of the US, wondering what the stock market is trying to tell us, and all the other madness likely to dominate our trading day.. I have to admit to an ever-so-slightly fuzzy head.

I’m not a Chelsea fan, but one of my clients is. Since he didn’t have time for a trip to Madrid for last night’s game, we watched it at Stamford Bridge instead. Yep, a gang of us were the only people in the stadium last night (which, to be honest, is a most enjoyable alternative to being surrounded by a pack of ravening Chelsea fans!) Although I’m a closet Gunner, it was a marvellous evening – made better by the last kick of the ball victory! (And that is absolutely the last time ever, and I mean ever, I will ever write something nice about Chelsea! )

Back in the real world, it’s a combination of the recent Yellen hawk-talk on a December hike and the prospects Trump will get his tax-cuts and modest reforms passed that have pushed down Treasuries and hiked up the dollar. Rest of global bond market is following in their wake on anticipated global recovery.

I’ve attached a graph (courtesy Martin Malone), showing the 2017 bond market – a series of 2-3 week crashes followed by longer rallies. Looking at the “shapes” you might conclude this bear phase is going to reverse into a rally. But, this time may be different – although we’ve said that before! Some of the factors are obvious; like the coordinated tightening bias across Central banks now embracing normalisation (yep, even the ECB accepts it) and improving economic outlooks, but we’ve also got rising corporate sentiment and a shift towards more positive government policy initiatives at a time when global output gaps are turning positive (after years of post-crisis negatives).

It all points to a longer-term bond bear market.. Its coming… the question, as always, is timing…

One sign its close is we’re seeing more signs of strain in corporate bond spreads as folk realise that being paid a few basis points more for a load more risk “because we needed the yield” is unlikely to prove a long-term career multiplier.

Yet, you wouldn’t know there is any risk of spread de-compression if you talked to new issue buyers. That would be heresy. Such is the hunger for assets, the creed of “ever tighter” has become rote. When some syndicate head is quoted in the FT saying “this is a hot issue… you get a decent yield for what is a highly rated issuer..” you have to wonder exactly how much his weekly recreational pharmaceuticals bill comes to…

The market clearly agrees with him. He was talking about Saudi Arabia’s multi-tranche deal at 145 bp (10-yr) over Treasuries, which offered a “good spread” (US readers: sarcasm alert) over Treasuries as $40bln of orders chased a $12.5bln deal causing the deal price-talk to ratchet in and tighten after launch. But… really.. is Saudi so devoid of perceivable risks that the deal provided a “yield-Christmas” to the lucky buyers?

I have a list of things and places I know are likely to cause me sleepness nights in coming years.. so why put them in the account?  

Meanwhile, I had a number of interesting discussions with clients, analysts and my own Macro-man, Martin Malone, yesterday about Trump and policy. Thus far, Donald has achieved a remarkable clean sheet in not passing any of his headline policies. Although the Tax-cut plans are bound to trigger open warfare on Capitol Hill, the consensus among Washington watchers is increasingly positive they will get passed. Not everyone agrees – but some of the numbers and probabilities point to a good chance of getting them passed this year or early next year.

The tax reform policies are certainly worth a look . They could be real game changers (especially allowing US corporates to repatriate the enormous amounts of cash they’ve stockpiled offshore (mainly in Dublin apparently!). (If nothing else, it might stop the EU getting their hands on disputed taxes!)

Now all this positivity about US policy and the end of bond markets must be positive for stocks – well, so you’d think.. But my stock guru, Steve Previs, (a man who wears wizard robes and a pointy hat in the office, who’s idea of fun is drawing lots of lines on charts and incanting from the Book of Nison!) reckons the charts are telling him there is imminent trouble ahead. He’s talking a “Global Financial Reset.” I’m still sticking to a short-sharp stock correction next month and then its “buying-boots-on” time!

Finally, as if to illustrate were in la-la land, I found myself deeply engrossed in a fascinating Bloomberg article about a young Citicorp banker who’s made a stunning success selling new synthetic CLOs over the past few years.

I couldn’t help but reminisce about my own youth, and as I read the tale I was transported back to the 90s and early Naughties…. as we pushed incredibly complex (but actually very very simple) packaged derivative deals on semi-naïve investors. (And pushing is the right word – I could tell you stories that make Narcos look like Trumpton.)

As I read through the story, I realised the young lady is doing today exactly what we did then… persuading investors a bit of complexity and yield makes it worth the risk. And like we did then, she probably believes utterly in the product.

A line came unbidden to my mine: “The real test of these credit derivative based products will be in a crisis situation..” How wise that commentator was.. oh.. it might have been me!

Of course, we got carried away. Structured derivatives got more and more complex, culminating in the CPDO – a fiendish bouillabaisse of over-leverage and rolling low grade debt. Somehow ABN managed to persuade the ratings agencies these were AAA investments. When it all went wrong, they went predictably horrible.

Apparently the new synthetic CDO market is lapping up new supply.

I simply remind you of Blain’s market mantra no 3: “The Market has no memory.”