Negative Yields: The Cruelest Month
T.S. Elliot described April as the cruelest month, but if one slides from poetry to history and negative yields, September has its own say in the matter. Historically, September has been unkind to equity investors, delivering an average loss of 0.7% and falling 60% of the time since the Second World War.
And history, at least so far, seems to be confirmed, as the first week of September limps along on the back of Texas floods, N. Korean tensions and another Tropical punch heading toward Florida.
But that of course, is not even the tip of the iceberg, as we also face the prospect of a government shutdown in DC while a host of central banks scurry about the globe this month trying to manage markets like a thermostat (yet deep down knowing they can’t).
Equally likely, however, is the debt ceiling and the budget get postponed… So maybe September will get a 90 day reprieve…
In any case: buckle your seatbelts. Can-kicking will end someday.
As for the US Debt Ceiling, this may not be your ordinary re-play of party brinksmanship before an 11th hour “miracle.” In the past, of course, there never really was any debt ceiling miracles—just a can-kicking extensions of debt.
America, since the Eisenhower administration, is kinda like a family living off credit cards bailed out by obtaining more credit cards…
Today, the United States is sitting on a $20T credit card bill and needs a new Trillion or two just to keep the lights on in DC. GOP hawks are tired of debt without revenue and Democrats are, of course, tired of Trump, who is, meanwhile, insisting (behind threats of a shutdown) upon adding a Mexican Wall (which I thought Mexico was supposed to fund?) into the US debt tally.
In short, there’s a lot of moving parts that will need to be in sync to avoid a potential crisis at month’s end. Yet being in “sync” is not something any of us could say about current DC legislation.
Mnuchin, meanwhile, confidently insists that there is no scenario (including Hurricane Harvey relief) in which the US won’t pay its bills—i.e. raise the debt ceiling—by September 29. This, of course, would mean, among other things, that T-Bills will be issued (and then bought) in “sync”—but the T-Bill curve as of September 1 suggests the markets aren’t as certain as the Cabinet.
This month’s docket has the central banks of Brazil, Mexico, England, Russia, Japan, Australia, the EU and the US convening separately.
September should thus prove to be an interesting month for these academic bankers, who after nearly a decade of globally pumping up asset bubbles with money printing and low to negative rate setting, are facing the hard-to-ignore dilemma of “damned if you do, damned if you don’t.”
That is, deep down, these guys and gals have to know that central banks can’t build bubbles with impunity. If their central bank steroids stop, the bubbles pop. But if the central bank steroids continue, their effect (which Charles H. Smith cleverly compared to insulin insensitivity) eventually wears off, and the asset bubbles they conceived (the biggest ever) just pop later—and bigger than ever…
Either way, the central banks have their backs against a wall, for having replaced normal markets with artificial ones, the credit/equity Frankenstein they’ve built around the world is poised for an in inevitable and monstrously unhappy ending.
Tied, of course, to central bank policies gone wild, is the impact they have (and will continue to have) upon currency and bond markets. In Europe, the ECB is hinting at a timeline for ending its money printing steroids (i.e. QE) this fall, with their currency already at 2-year highs. If the money printing ends or “tapers,” the Euro should rise, putting exports against a huge headwind.
The British Pound, of course, has the opposite problem, descending to lows not seen since last October. When the “Bank of England” (which, as a reminder, is in fact private and neither a “bank” nor “of England”) meets next week, it will need to balance this dwindling currency against declining wage growth and employment data. In this backdrop, expect more doves (i.e. can-kicking) than hawks in the response memo…
Meanwhile, in the US, the Fed, always the posterchild of “forward guidance,” has been trying to avoid a panic by telegraphing its plans to reduce its post-08 balance sheet. Key to this highly forewarned project is a reliance upon a manageable yield on the 10-Year, which for now, fortunately, is at 2017 lows.
But for QE to be reversed without consequence seems a bit too easy, and the Fed is assuming it can do its magic without widening credit spreads, boosting yields or maiming equities. Like Deutsche Bank’s chief economist, Torston Slok, I’m not as confident as the Fed… As Slok bluntly observed: “It cannot be asymmetric such that QE only has positive effects and reversing QE will have no negative effects.”
In case you’re wondering what kind of “negative effects” central bank perma-bids have on markets now and to come, let’s just consider sovereign bonds. Let’s also consider that oh-so-important equation that all bond investors learn on day 1, namely that Yield = Coupon/Price.
If central banks, rather than bond markets, are buying government bonds by the trillion-load, that obviously has a big (aka “simulative”) impact on the Price (i.e. denominator) of bonds. As these prices artificially rise (i.e. in a central bank created bond bubble) the Yield (return) goes down.
So as these central banks pat themselves on their much-publicized backs for the “global recovery” they bought in the years after the 08 Crisis, you and I might want to remind them (and ourselves) that these geniuses killed the bond market…
As of today, the price of bonds has been pushed up so artificially high that now much of the world’s sovereign bonds are posting negative yields—which means bond holders are actually paying to lose money. That’s not a recovery—that’s a distortion, plain and simple.
This month JP Morgan reported that the market value of sovereign bonds trading with negative yields within its JPM GBI Broad Index rose by 60% to $7.4T.
Yep. SEVEN-POINT-FOUR TRILLION DOLLARS of negative-yielding government bonds.
Morgan reported that the bulk of this rise came from Japan—the very country who invented Quantitative Easing in the rubble of its 1989 Nikkei crash–and now the veritable canary in the coal mine for testing the failure of subsequent global central bank policy.
What’s even more crazy is that Japan has desperately been trying to reduce the amount of government debt its central bank purchases, yet has seemingly lost control of the Frankenstein it created.
Japan, of course, is just one of many dominoes poised to fall in the central bank mess the world and markets are now facing. Trillions in negative-yielding bonds float across the EU today as well.
I’ll write more specifically on the bond market in later posts. For now, and as always, keep your eyes on the yield curve—and in the US in particular.
When bonds lose the support of central banks, they will gyrate, teeter, and eventually fall in value, thus pushing up yields. Watch that yield on the 10-Year… It’s like a barometer that even the Fed, one day, won’t be able to control.
September 06 2017