Forget Stocks, Look At EU Bonds - They Are The Real Problem

Authored by Tom Luongo,

I’ve been banging on for months along with Martin Armstrong that the real problem overhanging these markets is not an over-priced U.S. equity market.  That’s a sympton of a much bigger problem.

The real problem is an over-valued European sovereign bond market.

Looking at today’s bond market we see technical breakouts on yields to the upside across the continent.  And we’re not talking the usual suspects here, like Italy, Portugal or Greece.

No, we’re talking about Germany.

bunds

Note the cluster of resistance at 0.5%.  The market rejected taking yields on German 10 year debt above that level no less than six times in the past fifteen months.

Today, yields are at 0.685% and tomorrow is the end of the month.  Looks like we’re going to get a major bearish signal in German debt tomorrow.

While all the headlines are agog with stories about the Dow Jones dropping a couple hundreds points off an all-time high, German bunds are getting killed right before our eyes.

The Dow is simply a market overdue for a meaningful correction in a primary bull market.  And it’s a primary bull market brought on by a slow-moving sovereign debt crisis that will engulf Europe.

It’s not the end of the story.  Hell, the Dow isn’t even a major character in the story.

In fact, similar stories are being written in French 10 year debt, Dutch 10 year debt, and Swiss 10 year debt. These are the safe-havens in the European sovereign debt markets.

Meanwhile, Italian 10 year debt?  Still range-bound.  Portuguese 10 year debt?  Near all-time high prices.  The same this is there with Spain’s debtAll volatility stamped out.

Why?

Simple.  The ECB.

For Euro Eyes Only

The ECB’s quantitative easing program and negative interest rate policy (NIRP) drove bond yields across the board profoundly negative for more than a year.

And despite ECB President Mario Draghi’s jaw-boning and assurances, he can no more exit this program than Bitcoin billionaires can exit the crypto-market and get back into dollars without the kind of pain that would stagger, if not break, the industry.

But, the ECB is trapped and cannot allow rates to rise in the vulnerable sovereign debt markets — Italy, Portugal, Spain — lest they face bank failures and a real crisis.

The problem with that is, the market is scared and so they are selling the stuff the ECB isn’t buying – German, French, Dutch, Swiss debt.  In simple terms, we are seeing the flight into the euro intensify here as investors are raising cash.

The euro and gold are up.  The USDX continues to be weak even though capital is pouring into the U.S. thanks to fundamental changes to tax and regulatory policy under President Trump.

In the short term Dow Jones and S&P500 prices are overbought.  Fine.  Whatever.  But, the real problem is not that.  The real problem is the growing realization in the market that governments and central banks do not have an answer to the debt problem.

Trump is being fought every step of the way to keep the dream alive of a U.S. economy brought to the same low state of the EU’s democratic-socialist ‘shitholes.’  He’s winning, by the way, because, for the most part, he is on the side of rational, incentive-based economic theory.

He’s hopeless on some issues, but the core of his tax-cut plan supersedes those failings.

The Real Savings Story

However, the real story is the end of the current monetary system and the repudiation of neoliberal/neoclassical economics. Despite Armstrong’s wailings against the Austrian School of Economics and the Quantity Theory of Money, this is Mises’ revenge.

He actually makes the Austrian case in a recent blog, but refuses to admit that what he’s describing are the effects of money printing rather rooting out the underlying cause of the deflation he’s rightly seeing.

It’s too bad, actually.  Because a mixture of his cycles work and a deeper understanding of Austrian Business Cycle Theory, which is NOT synonymous with the Quantity Theory of Money, would be a a synthetically more powerful combination than either of them on their own.

Printing money undermines the confidence in the value of it.  There is no way around that.  In fact it is the entire point of printing money.  At most points in the inflationary boom/bust cycle increasing the money supply will create price inflation.

Again, that’s the point.

This price inflation comes from the confidence that people have in the issuers of the money that they have things under control, that they are printing the right amount of money to offset price deflation and spark a boom.

And as long as that confidence holds, then expansionary monetary policy will create a new economic boom that can be measured in increasing nominal output.

However, in doing so the money issuers, in this case the central banks, distort the structure of production by mis-pricing the cost of money, the interest rate.  They artificially drive interest rates below the real rate of the market’s risk tolerance.

This signals to producers to engage in projects that there isn’t enough capital in the pool of real savings to cover.  I covered this in a post at length last year.

But, there will always come a point where the creation of more money units will not inspire enough confidence in the system to maintain asset prices being artificially propped up by more money.

And when that happens it will be the boom to end all booms, where printing of more money will not create more confidence but less.  And even a core economy like the U.S. will be bound by this fact.  If Trump is allowed to do his job he will postpone that day for a while, but the structural problems of the U.S.’s economy are too deep to avoid some damage.

Trapped, Trapped I Say!

That’s where the ECB is now.  There is no political will in Europe to change its taxing and regulatory environment.  In fact, Germany wants more punitive Austerity not less.  It demands the worst possible combination of conditions on its confederates, lower government spending (good), higher taxes to pay for the debt servicing (awful).

It’s nothing but a capital destructive scheme meant to punish and destroy the prospect of future growth.

The ECB is flirting with losing the confidence of bond traders and institutional investors who rightly see all European sovereign debt as over-valued, especially as rates in the U.S. begin to rise.

We have been in a deflationary cycle since 2008.  The Fed printed money to save the banks. The money never circulated because it paid the banks to park the money on reserve with the Fed, interest on excess reserves.

However, that interest did, along with government deficit spending,  keeping prices for those things with inelastic demand curves — food, electricity, health care, housing — continually rising while real wages contracted.

The U.S. economy is about to be unleashed by Trump’s tax cut law.  It will be able to absorb higher interest rates for a while.  Yield-starved pension funds, as Armstrong rightly points out, will be bailed out slightly forestalling their day of reckoning.

And in doing so, higher rates in the U.S. are driving core-rates higher in Europe.  An overly-strong euro is crushing any hope of further economic recovery in the periphery, like Italy.  The debt load on Italy et.al. has increased relative to their national output by around 20% since the end of 2016.

This will put the ECB at risk of a massive loss of confidence when Italian banks start failing, Italy’s budget deficit starts expanding again and hard-line euroskeptics win the election in March.

As capital is drained out of Europe into U.S. equities, the dollar, gold and cryptocurrencies, things should begin to spiral upwards rapidly.

This is the story the bond markets are telling us today.

Comments

new game CHX13 Wed, 01/31/2018 - 06:19 Permalink

austerity, because these fuks will never ever admit they are wrong. never. so greece to the world. simple shit maynard.

how's that austerity working for ya? mixture of cat chow and beef? try the pork fondu bits with ground up nostrils, bones and tallow. good shit maynard. oh, and housing costs reflect the results of all this duct tape to hold the phony markets in place. face ripped in bonds, coming...

In reply to by CHX13

martydz Wed, 01/31/2018 - 04:13 Permalink

Bonds big problem. 

 

We can stand around all day finding the problem or get busy making money.

Shepwave traders have been calling market moves spot on

 You guys keep trying to find the problem. I will be trading these markets. 

 

ROFLMAO

 

martydz Wed, 01/31/2018 - 04:13 Permalink

Bonds big problem. 

 

We can stand around all day finding the problem or get busy making money.

Shepwave traders have been calling market moves spot on

 You guys keep trying to find the problem. I will be trading these markets. 

 

ROFLMAO

 

P.K.Snosage Wed, 01/31/2018 - 04:24 Permalink

Fantasy Island: Do you guys even believe this stuff as you write it, and do you really believe anybody but a few cranks are taking you seriously.  If your predictions are so great, trade on them and retire; save us all the lugubrious, self-serving sentiment;

 

"As capital is drained out of Europe into U.S. equities, the dollar, gold and cryptocurrencies, things should begin to spiral upwards rapidly."

 

 

CHX13 Wed, 01/31/2018 - 04:29 Permalink

Good read, but still slightly off IMHO. Once a critical mass loses confidence in this con-game the currency itself - THE unit of account in any given currency area - becomes toast. What we now have is a case where all fiat currency areas "should be toast" at the same time. This is not only about the €, no. How should the US financially survive if they have to service interest rates at say 4% for 20++ T debt ? China-debt, British debt, Japanese debt? Toast, toast and more toast - we are now living  in Weimar World and there is no painless way out. The cryptos have been sniffing this out, but ultimately it means a revaluation case for gold, or some sort of gold-backed trade notes (possibly with implemented blockchain) as a start. The Shanghai gold exchange and yuan-denominated oil contract might just be the first step in that direction.

J J Pettigrew CHX13 Wed, 01/31/2018 - 05:50 Permalink

>" if they have to service interest rates at say 4% for 20++ T debt ? "<

In 2007 when the Dow raced to 14K, short rates were 4.5% and the national debt was circa $7 Trillion.

Now the Dow at 26K, rates at 1.5%, and the debt at $20 Trillion. How can the supply of something, govt debt, TRIPLE and the price go up? The Federal Reserve. SO, the Fed declares they will trim their balance sheet at $120 billion a year.....that will take 32 years ($4 Trillion)!!!! This underscores the magnitude of what the central bankers have done in 9 years....and essential admits THEY CANT GET OUT.

The government debt creation, without market "pain" from simple supply and demand forces, has pumped equities.

Where would the markets be if the government had to borrow at real rates, say 5%? What of all the stock buybacks funded with cheap leveraging, or the 3% dividend plays?

It is easy to see that the central bankers pumped the equities and allowed the debt creation with essentially no pain........yet.  Keeping rates below the terrible metric of the CPI (a scam in itself) is a drastic panicky measure.....

 

In reply to by CHX13

SDShack CHX13 Wed, 01/31/2018 - 13:23 Permalink

All fiat will not collapse at the same time. The Petro$ will be the defended by the USSA to the last, and that means sacrificing all other fiat first. Numbers don't mean anything because it's all world wide debt ponzi. All that matter is maintaining the ILLUSION of stability. Japan is gone. This article correctly shows that the Euro is next, with signs already pointing this way... Brexit and other _exit efforts ongoing, North/South EU Debt Crisis, Failed Immigration Policy leading to Failed State Govts, etc. This is descending into a sociopathic banker game of self-survival, and the USSA with the biggest Security State will be the last one standing. The USSA will use whatever levers are needed to stay alive... financial sanctions, trade sanctions, even all out world war if necessary (probably courtesy of some False Flag, ie. terrorists, Russians, North Koreans, Iranians, fill in the blank). Ultimately, the USSA is probably fighting a losing game, but do not believe that they will not fight to the death, or that they are unwilling to take down everyone else first to try to survive. This game has a long way to go yet.

In reply to by CHX13

CHX13 SDShack Wed, 01/31/2018 - 14:35 Permalink

No doubt about it, they will fight the inevitable to the very end. Agree on the currencies, but the order, not so sure. I think the global house of cards will come down in one swoon (e.g. a TBTF bank that goes tits up or the West running out of fizzical aurum to lease into "the markets", aka to satisfy the bRICs demand for yellow bricks.; or a slow of there lynch pins that could cause a major financial detonation). Time will tell and i guess we will not have to wait for another decade... 

In reply to by SDShack

MPJones Wed, 01/31/2018 - 05:02 Permalink

Fiat currencies are useful tokens of exchange but cannot reliably be used as stores of wealth unless subject to strict discipline (e.g. a gold standard). Governments through national banks have for a long time been using currencies as a hidden means of taxation, the corrupt banking system skimming off huge profits at the same time. Such antics will of course undermine the confidence in the fraudulent fiat funny-money. Until the advent of Bitcoins et al we just have not had an easy to use alternative. We do now and fiat will either have to be brought under control (linked to gold) or will suffer hyperinflation.

J J Pettigrew Wed, 01/31/2018 - 05:46 Permalink

Hayek was right all along....Central Bankers/Planners are con men....

These economic theories are BS.....QE was a money dump. 

The tubes cant be taken out now, lest the patient dies......

It was all a crutch, not a brilliant economic ploy....and the crutch cant be removed.

For every action there is an equal and opposite reaction....and the debt BOMB cometh.

SDShack J J Pettigrew Wed, 01/31/2018 - 13:32 Permalink

Yep, you can't unwind or taper a Ponzi, and what we have is a Giant World Wide Debt Ponzi composed of a variety of smaller CB Debt Ponzi's. This is descending into survival of the fittest. The smaller weaker Ponzi's will be sacrificed in the hope that the "investors" move to the stronger Ponzi, which ultimately will be the Petro$. This is all just buying time to try to organize a NWO out of the engineered chaos.

In reply to by J J Pettigrew

Dragon HAwk Wed, 01/31/2018 - 06:49 Permalink

When we used to play Monopoly my brother always wanted to be banker  so he could steal 500's.

 Funny how nothing has changed except the board got a lot bigger.

Let it Go Wed, 01/31/2018 - 07:28 Permalink

Some things have not changed. Many people have failed to notice the Euro-zone debt crisis has taken a heavy toll on Italy where consumption and investment are expected to remain weak. The country’s economy has shrunk by around 10% since 2007 and output has regressed to levels not seen in more than a decade.

While Italy talks about its commitment to fiscal reform it continues to run a budget deficit of 3%. With government debt standing at $2.4 trillion dollars around 140% of GDP. This has spilled over to their banking system and resulting in the lack of faith we are seeing today. More on the subject of just how bad this is in the article below.

 http://brucewilds.blogspot.com/2016/06/italys-future-hampered-by-debt_22.html

Peter K Wed, 01/31/2018 - 07:33 Permalink

The Euro is a weapon of mass destruction.

The way to defuse that MOAB is by Germany to leaving the Euro and allowing the rest of Europe to reprice.

That's the first step and until the first step is not taken... there all whistling Dixie.

U4 eee aaa Wed, 01/31/2018 - 07:44 Permalink

I like this part:

 

This price inflation comes from the confidence that people have in the issuers of the money that they have things under control, that they are printing the right amount of money to offset price deflation and spark a boom.

It just shows how brainwashed we all are. Deflation is actually a good thing. It means you can buy more things with the same dollars or that you can buy $1000 worth of goods for $800 now and pocket the extra $200 creating more spending power down the road.

 

Only in a debt slavery plantation is this a bad thing

 

bshirley1968 Wed, 01/31/2018 - 08:51 Permalink

"Printing money undermines the confidence in the value of it.  There is no way around that.  In fact it is the entire point of printing money.  At most points in the inflationary boom/bust cycle increasing the money supply will create price inflation.

Again, that’s the point.

This price inflation comes from the confidence that people have in the issuers of the money that they have things under control, that they are printing the right amount of money to offset price deflation and spark a boom.

And as long as that confidence holds, then expansionary monetary policy will create a new economic boom that can be measured in increasing nominal output......................

And when that happens it will be the boom to end all booms, where printing of more money will not create more confidence but less.  And even a core economy like the U.S. will be bound by this fact.  If Trump is allowed to do his job he will postpone that day for a while, but the structural problems of the U.S.’s economy are too deep to avoid some damage."

This dude is an idiot. "Money printing undermines confidence.....confidence in money printing creates inflation......it "ends" when more money printing won't create more confidence.......and Trump can make the party last longer by being irresponsible with the debt (printing more money) and make the pain even worse when it comes? WTF!

You jacksses that applauded this tripe and say you understood it only say that because he threw in a couple of plugs for your hero. This guy and you are idiots. You are the sheeple that have "confidence" that we can solve a debt problem.....with more debt. You are no different than an heroine addict waiting to someday overdose. Enjoy the ride.