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Out of the Box: Living in a Fairy Tale

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“When I used to read fairy tales, I fancied that kind of thing never happened, and now here I am in the middle of one!”
-Alice in Wonderland

Here we are at a 2.04% yield on the 10-year Treasury. It seems low, quite low, until you stare at the other 10-year sovereign debt in the world and then it seems unbelievably high. Germany is -0.35%, while Italy is at 1.65% and even troubled Greece is at a 2.08% which is just 4 basis points higher than America’s yield. “How did this happen,” you may wonder, and it is all the result of central bank intervention, caused by the troubled nations in Europe, and the problems in Japan, and these nations, it should be noted, absolutely control the actions of their central banks. There is no “Independence,” as is the case with the Fed.

Most of the countries in the European Union are virtually broke, it appears, and so the European Central Bank has created money from nothing, other than a blink, and bought both sovereign and corporate debt out of Mr. Draghi’s “free cash flow.” Quite remarkable, when you think about it. Most nations in Europe cannot afford their budgets, or their social programs, and have lost their ability to raise taxes, without having their politicians thrown into the streets, and so they manufactured money in their computer rooms, and lowered the yield on their bonds, to less than Zero, in many cases.

The truth is, which no one ever mentions, or wants to talk about, is that the nations in Europe are, in fact, virtually insolvent.
America is not quite there, yet, but may be approaching the threshold, as cornered by the world’s other central banks. We have already passed one milestone though, in the United States, and I bring it to your attention today. With our core CPI rate at 2.10%, according to the Bureau of Labor Statistics, we now find, even in the United States, that our Treasury Notes are negative, in many cases, to our inflation rate which means that savers are losing money.

So, with Core CPI at 2.10%:

Bond/Index Yield Spread
3 Month Bill 2.07% -3 BPS
1 Year Note 1.94% -16 BPS
2 Year note 1.81% -29 BPS
5 Year Note 1.80% -30 BPS
10 Year Nite 2.05% -5 BPS
Bloomberg Corp. Index 3.18% +108 BPS
Bloomberg U.S. HY Index 5.96% +386 BPS

*Data according to Bloomberg.

There you have the data. So, if adjusted for Inflation, Treasuries through 10 years are at negative yields. Not negative yielding less than Zero yet, but we will soon be headed that way. The next FOMC announcement is July 31 and I fully expect a rate cut of at least ¼ point and maybe more, if certain people on the Fed, and in the White House, get their way. I also expect the Fed to announce that they will begin buying Treasury Bills and so the inversion in the Yield Curve will be straightened out, in short order.

More than 10 years after the global financial crisis, the unemployment rate in Europe, where high jobless figures in Greece (18.0%), Spain (13.9%), Italy (10.7%) and France (8.8%) come nowhere close to what America has achieved, which is the lowest unemployment rate in the last 50 years. So, before the FOMC meeting, the ECB will come up to the plate this week, on July 25. This will set off a new round of fireworks, in my opinion, and pressure the Fed even further.

I expect the ECB to cut rates even further, expand its bond buying program, perhaps institute a new round of Quantitative Easing, and expand their balance sheet once again, and maybe announce the initiation of an equity buying program. I think some bold moves are coming as the economies in Europe are worsening rapidly. Wonderland is about to grow once again, both in scope and size, in my view.

“In that direction,” the Cat said, waving its right paw round, “lives a Hatter: and in that direction,” waving the other paw, “lives a March Hare. Visit either you like: they’re both mad.”
-Alice in Wonderland

You see, there is a kind of Madness, in all of this. Interest rates at less than Zero, and going to a new level where they are going to be “More” less than Zero. European economies that are sinking, where new taxes cannot be raised, and so the way out is a grand scheme of Monetization that the Mad Hatters of Frankfurt likely proposed at some German Tea Party. Further, there is no end in sight, as Europe may be heading towards Japanese levels, where the Bank of Japan has more assets and liabilities than the nation of Japan.

Let me assure you, the pressure on the United States is growing. There are yield issues, currency issues, and the heat is on both the U.S. Treasury and the Fed. Consequently, in my estimation, and regardless of the political rhetoric, our government is going to have to respond to staunch the bleeding cause by the various European capitals. There is just not going to be any choice.

This is just not a case of “It’s Different this Time.” That is not going far enough, at all. Negative Yields have never been seen in the history of the world before, not in the thousands of years of recorded history, and so we have entered into a fairy tale, long dreamt of by national governments, where money can be borrowed at less than nothing, but never before realized.

Wonderland has been achieved!

“That sounds impossible,” said the Hatter. “We absolutely must give it a try!”
-Alice in Wonderland

Mark J. Grant
Chief Global Strategist, Fixed Income
Managing Director
B. Riley FBR Inc.
U.S. 954-468-2366

Information herein is for general use; is not unbiased/impartial; is current at publication date, subject to change; may be from third parties; and may not be accurate or complete. Opinions are the Author’s, not B. Riley FBR, Inc., or their respective affiliates or subsidiaries. This is not a research report or solicitation or recommendation to buy/sell the subject securities. Investment factors are not fully addressed herein. B. Riley FBR Inc. and their affiliates may have a proprietary position in the subject securities.
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