Below, we consider today’s bond market in the backdrop of key themes such as bond yield analysis, central bank distortions, massive national debt figures, global trends, QT, and the opinions of a bond legend, Bill Gross. The main question we’ll ask is this: is the bond market safe?
Everywhere—from the Mainstream Financial Media (MSFM) to the fringe of the economic blog-sphere—all eyes and memes tend to focus on stocks, the stock markets, and (record-breaking) stock behavior, from Netflix to the NASDAQ.
In this backdrop, it may be worth an occasional reminder that bonds matter too—in fact, the bond market in particular and the debt numbers we face today in general—make bonds (and hence bond discussions) arguably more important than stocks.
So let’s re-revisit bonds and the bond market. Let’s re-cap prior blogs, examine current news and the key themes to any good bond discussion and consider not only the bond past and present, but its potential future.
Theme 1: Yield
In the tail end of a beat-down I gave Larry Summers last May, I closed the piece by addressing the topic of bond yields as the real tea leaf for measuring market direction. (The VIX, to me, is fairly unhelpful in the current environment as a leading indicator.)
Given that bond yields move inversely to bond pricing, as bond yields rise, we can thus know bond prices are falling. I’ve consistently used the US 10-Year Treasury as the main thermometer for measuring bond health in particular and market direction in general.
Specifically: once the yield on the 10 Year passes 2.6% (and holds), start to worry… This means a critical price barrier has been pierced and the trend down in prices (and up in yields) is in motion.
Theme 2: Central Bank Distortions
In July, we looked at the role of central banks in general and of the US Federal Reserve in particular in creating artificial demand—and hence artificial price support—for an otherwise sickly credit market.
This issue of Fed support for the markets is not a matter of bull or bear debate. It’s simply a fact: in 2008 our bond market, tilting on the sandy foundation of mortgage-backed junk sold as investment grade quality, faced a well-earned collapse, which the bond market avoided by simply faking it.
That is, the Fed just bought the stuff nobody else wanted, acquiring garage-sale junk at Tiffany’s prices. In essence, the Fed kept the bond market on a big, fat, National Visa card.
It worked too. QE1-3 and the Fed’s ZIRP policy gave an otherwise limp credit market trillions of dollars of steroid “stimulus” and thus a very distorted illusion of bond market strength.
Prices rose so fast that yields on everything from junk bonds to Treasuries were compressed to record lows, forcing investors further and further out on the risk branch for less and less yield/return.
No one, bear or bull, can deny the risk-adjusted impact of this stimulus nor the artificial wind beneath this bogus bond market’s wings. In short: the bond market is not a real market, it’s a bank-supported illusion.
One consequent question (raised recently here on Signals Matter) in such a backdrop of Fed stimulus, was this: how will the bond market do when the Fed stimulus reverses toward Fed tightening?
Theme 3: A Market Culture of Debt and a BLS/Fed at Risk of Dishonesty
The Inflation Lie
The US has turned an historically unfortunate corner from leading the world as a manufacturer and creditor to devolving into a leading debtor who has outsourced the bulk of its manufacturing overseas to the detriment of fly-over America.
To maintain an illusion of strength, America now issues debt rather than post any advances in GDP, which annualizes at less than 1.8% since our post-08 “recovery.”
Given that our nation now survives on debt rather than productivity, our country survives by sustaining the illusion that our debt instruments (i.e. the 10 Year UST) are still worth buying. With the US 10 Year yielding only. 2.2%, the Fed and BLS have resorted to years of flat-out dishonesty in under-reporting inflation to keep the reported inflation-adjusted yields above zero.
If actual inflation (closer to 8%) were accurately reported, the yields on our national bonds (the very Achilles heel of our debt-nation) would be negative and the fantasy of US relative outperformance, as well as its bond market, would abruptly end.
These are not rants, but merely ignored truths supported by data and math available to anyone who wants to stare such sad figures in the eye.
The Debt Monster
Today, corporate and non-corporate US business debt teeters at $13T. The combined levels of US household, business and government debt (including our $20T national deficit) chimes in at $66T and the total value of these numbers, when added to the +$200T of unfunded liabilities which cover such national obligations as, inter alia, Medicare and Social Security, reaches a monster-like debt sum for which there is literally not enough money in the world to pay.
If the foregoing isn’t evidence enough of a debt (and hence bond market) problem, the following offer further, neon-flashing, signs of a nation and bond market addicted to (and too comfortable with) debt:
–Junk loans/bonds outstanding today are double their pre-crisis 2008 peak and offering relatively little yield (3-4% spread over the US 10-Year) for heightened risk.
–subprime auto loans are following an underwriting template of risk-aversion identical to pre-08 subprime home lenders. Today, the industry embodies over $1T in outstanding debt, most of it junk.
-The US retail sector is buried under the weight of impossible debt burdens in the wake of poorly envisioned but promiscuously inspired LBO and PE poaching jobs ushered in by the Fed’s low rate monetary policies.
In short, we’re in deep debt doodoo here in the US. This means our debt market—i.e. the bond market—in which large percentages of these debt instruments are traded, faces obvious risks: namely the classic threats to bonds: rising default, inflation and interest rate risks.
In such a backdrop, to think of bonds as a safe-haven in 2017 is akin to the illusion that Pearl Harbor was a safe harbor for the Navy in December of 41…
Theme 4: Bond Risk Has Gone Global
The US Federal Reserve is hardly acting alone in acting as a fake source of demand for unwanted bonds, sovereign to corporate. The BoJ, ECB, PBOC, Swiss National Bank et al are also printing trillions out of thin air to buy government and private debt that would otherwise have sunk to the floor by now.
The result is negative yielding sovereign bonds throughout Asia and Europe where investors are literally paying to lose money from the moment their brokers call in the bid. This is credit market distortion at the highest level, yet hardly mentioned in the MSFM.
In Europe, for example, the distortion is so great that the yield on its riskiest bonds—the junk credits—is currently less than the already anemic yields on the US 10-Year Treasury. Please, think about that for a second. It’s crazy: European Junk bonds yield less than the US 10-Year.
Theme 5: Monetary Policy Conditions Are Shifting from Favorable to Unfavorable
If bonds in the US and abroad have been enjoying years of stimulus from Quantitative Easing and low rate pegging, the fact the US Fed is (at least for now) heading toward Quantitative Tightening and higher rates suggest further price declines rather price support in the bond markets.
I’ve written at length in a prior blog about the shift from QE to QT, and this shift, however unreported or gradual it may be, is hardly a tailwind for a bond market already riddled with the risks.
A Bond Legends Speaks
Of course, no discourse on the themes above would be complete without mentioning the views of a bond rock star who knows credit markets well. One who comes immediately to mind is Bill Gross, the former PIMCO head now trading credits for Janus.
Bill Gross is bluntly admitting the party is nearing an end for bonds, and his bogey for this bull-market reversal is when we hit (and hold) a 2.4% yield on the 10-Year UST (as opposed to my 2.6% threshold).
Bill Gross thinks yields will hit this number as wages and inflation rise, thus sending bond prices down at a continual trend/pace.
For the bulls, such risks seem far away, as they believe inflation is far off and wages won’t rise too fast. Janet Yellen, for her part, is acting publically puzzled as to why we have low inflation in this “strengthening” job market.
In fact, she is calling this low inflation a “mystery.” But as my prior blog post suggest (without trying to polarize things), Yellen is flat out lying about inflation, which is something we seem to be getting used to in so many areas of MSM and MSFM’s discourse/reporting.
Friday, the BLS came out with the last CPI fiction, falsely bemused by another false (and weak) inflation report that now pretends that annualized inflation is at 1.7%.
Anyone who can fog a mirror knows that US living expenses are rising infinitely higher than 1.7% this year. But as we keep saying, the Fed (and BLS) won’t report the true inflation numbers, because to do so means admitting to an inflation rate higher than your return on the US Treasury.
In essence, the BLS and the Fed are like children afraid to show their real report card to mom and dad; so they hand over a fake one…
For his part, Bill Gross (like us at Signals Matter) is watching the yield curve and not the public media or FOMC/BLS statements to measure real risk. If we see the 10 Year UST yields pass 2.4-2.6% and hold, beware.
Beware as well that the market is seeing a measurable rise in demand for put options on 10-year futures that expire shortly (and with strike prices that anticipate yields well above Gross’s 2.4% bogey).
Summing It All Up
The foregoing themes—suppressed yields, central bank distortions, unprecedented debt levels, global trends, bearish policy shifts and bond-expert testimony—all point out, as well as point to, headwinds ahead for both US and global bond markets.
We write these blogs not to stir fear or rant for the sake of ranting, but to put the public as well as our own subscribers on notice as to potential risks ahead. As importantly, we want all of us to (at the very least) question prior assumptions and traditional notions about bonds as “safe haven” allocations.
We feel those traditional notions, like traditional markets, have been so fundamentally altered by the post-08 responses of markets, central banks, and the MSFM, that reliance upon yesterday’s ideas may put tomorrow’s portfolios at significant risk.
Whether or not you share the extent of our concerns, we ask that you weigh the pro and con postures of today’s bond markets and put your own common sense (as well as your financial advisors) to an honest test.
As for me, I see an ominous dorsal fin swimming toward the credit markets.
Be safe out there.
October 15 2017