From Blain's Morning Porridge, Submitted by Bill Blain of Mint Partners
Stop worrying about the US yield curve - its a distortion. Something much worse is around the corner....
A bit of a feeding frenzy in the new issue primary bond market as 21 deals hit the screen and went fairly well. With Thanksgiving tomorrow it’s likely the tail of the week will be very quiet, but our primary trading team reckon there is still plenty of momentum. We’re likely to see another two weeks of proper activity before the holiday slowdown. There are a large number of deals queued up and still to come to market.
I wonder if the Credit Markets will be as busy next year?
It rather depends. Regular readers will know I’m uber-bearish and expecting the big bond market crash coming sometime soon, but others point to the US yield curve as evidence of a slowdown and therefore favourable conditions for the bond binge to continue – what’s not to like for issuers looking for almost zero cost money?
Frankly, there is far too much guff and nonsense about the US yield curve… so, it’s time for me to scare you some more, and add some Blain mumbo-jumbo to the mix.
It’s pretty simple.
The flatter US curve is NOT sending a deep meaningful warning of looming recession. It’s hiding something much worse….
The short-end of the US curve reflects what the Fed has done in terms of hiking rates. But, the long end of the US Curve (10-30) is being driven by very different forces. It has flattened because of interest rate differentials between the ZIRP rest of world and the rate normalising US, but also on the fact external investors effectively drive US rates because they are the forced buyers! Ongoing QE distortions in Europe and Japan are still driving close to Zero domestic interest rates – forcing investors offshore. Global demand for duration partially explains why the US 10-30 curve appears to have flattened.
The transmission effects of $5 trillion QE in last three years is a massive allocation towards US assets – which explains why the 10-yr is sticking round 2.5% and the term perimum is negative. Remove these effects of global distortion and the US curve would look much steeper and cause far less fear, panic and mania than the yield curve doomsters perceive.
The yield curve is not the thing to worry about..
I did read another yield curve view on Bloomberg: “The yield curve is inexorably flattening because duration is the hedge, not the risk, when it’s paired with a long equity component.”
Anticipating the imminent stock market meltdown with long duration bonds kind of makes some sort of sense – but I’m convinced that is going to be a massively expensive strategy.
Why? Because something much more wicked this way comes…..
That dark thing is inflation.
Over the last 10-years – since the Global Financial Crisis – we’ve seen the main drivers of inflation stagnate across the board. (I’ve argued many times if you want to see inflation then look at financial assets.) While prices and inflation signals have flat-lined, the inflation Central Bank feared they would create through QE has been incubating in massively inflated real assets – stocks and bonds.
My Macro Economist colleague Martin Malone reckons an inflation shock is now a 50% plus risk! He points out all the major inflation drivers are coming back on line.
- Global inflationary expectations have risen dramatically this year
- Inflation data – which was deflationary 5 years ago, then flat, has now accelerated towards more normal levels
- The safe asset long-term rate – in effect government bonds – are beginning to normalise
- Output gaps are increasing and positive around the globe
- Real Asset Prices – particularly housing and real estate rose dramatically over last 3 years
- Risk Assets – like bond and stocks remain hugely inflated
- Oil and commodities prices are rising
- Jobs are being created around the world, and increasing number of countries now looking at supply side fiscal policy means wage inflation looks inevitable! The Philips Curve returns!
Malone has quantified all the inflation drivers and added them up. He reckons in inflation drivers haven’t been this high since 2007! (If you want the numbers – let me know!)
Ask anyone on the street about inflation and they’ll tell you it’s very real. Wages have stagnated for 10-years, but prices are clearly rising. And look at UK housing – up 50% over 5-years!
One further driver of inflation may be China. (Yep, I know – it’s too easy.. If in doubt about markets, blame China.) For years I’ve been arguing the real risk in China isn’t creating enough jobs to keep the populace happy – it’s actually been about a revolution caused by the increasingly perilous state of the Chinese environment.
The leadership has now made the environment the number 1 priority – they get it and are acting accordingly. Pollution is the enemy. It’s not just coal fired power stations, but agriculture is a major source of river pollution – especially from Pigs. So piggeries have been “emptied” and hog prices are through the roof. As these supply side policies hit prices, the government is forced to raise wages. Wage inflation driven by rising food prices.
Go figure what happens elsewhere as China drives up protein and carb prices.
* * *
And… back to Germany… I am indebted to some German readers for pointing out my knowledge of the German constitution is not a sound as it should be (the word being “inadequate”!) It’s not Merkel who can call an election, but former SPD vice-chancellor and now BundesPresident Steinmeier who makes that call. He is vehemently opposed to a second election. As a result it’s likely we’ll see a drawn out process and votes before an election can be called, giving time to put together a new grand coalition in which either the SDP participates with a strong left-wards shift, or a weaker minority government is imposed which will further focus German policy internally rather than at Europe.
One theme suggested last night is the SDP offering to participate in a new Grand Coalition – but only if Merkel goes… Time to hedge the Dax?