Out Of The Box: On the Dark Side of the Moon
I am often on the other side. I don’t mind standing there, by myself, as I write exactly what I believe. There is no “pimp,” there is no “tout,” there is just my honest opinion. Currently, I think the consensus viewpoint, about the Fed, is wrong. You, of course, will make up your own mind.
It used to be that the central banks were part of the markets, all of the markets. It used to be the general outlook that they had a large influence on the short end of the Yield Curve but not on the long end of the Yield Curve. It used to be, as exemplified by the “Bond Vigilantes,” that large financial institutions, and large money managers, could have a major impact on interest rates, and yields, because the amount of money that they wielded.
All of that is now history!
The line in the sand was the financial crisis of 2008/2009. The world’s central bank entered the markets to save the financial system. They learned what they could do, as a result of this, and they have never left. What they learned is that they could dominate and control the markets, utilizing their “Crown of Creation” cash, which is exactly what they have been doing ever since.
The central banks have gone from being “a force,” in the markets, to being “The Force,” and it is a position that they are not going to give up, because they can’t give it up. In the first place, these people are the only people on Earth that will not go to jail for creating money. In fact, it is part of their job to create money. Consequently, no institution on the planet can compete with them, as no one else is allowed to create money. All anyone can do is follow along, and try to front-run, what they plan to do next.
Hey, diddle, diddle,
The cat and the fiddle,
The cow jumped over the moon…
Having said all of this, I have not gone far enough. All of the world’s central banks report to a nation, or a group of nations, as is the case with the European Central Bank. This means that regardless of the hype about “Independence,” that these banks represent countries that have a budget, and social programs, that must be paid for and so these nations have learned what their central banks can do. The various countries have pushed their central banks to lower borrowing costs, and lower interest rates, so that the nation’s (nations’) budgets and social programs can be afforded. In effect, between the various countries and their central banks, they have rigged the system. The central banks have created separate economies, separate cash flows, that are concocted with a wink, a blink and a nod.
Wynken, Blynken, and Nod one night
Sailed off in a wooden shoe,
Sailed on a river of crystal light,
Into a sea of dew…
If you think I am pushing the boundaries then I invite you to consider that the universe of negative-yielding bonds grew has grown by $1.2 trillion recently, pushing the total past $13 trillion for the first time ever in history. Bloomberg states that, “Joining the club of government debt with 10-year yields below zero this week were Austria, Sweden and France. Japanese and German rates plumbed fresh all-time lows amid a global bond rally that even got Wall Street pondering life, with Treasuries yields under 1.00%.”
Some 40% of global bonds are now yielding less than 1.00%, according to data compiled by Bloomberg. It’s not just all sovereign debt either. In the investment-grade market, negative-yielding debt now comprises almost 25% of the total amount outstanding. More unreal is that about 2.00% of the Euro high-yield universe is now negative yielding, according to Bank of America Merrill Lynch.
If I would have said this would happen, prior to the 2008/2009 crisis, every person on Wall Street would have thought that I had lost my mind and yet, now, the unthinkable has become the reality. What everyone would have said couldn’t happen, has happened. The impossible has blinked into existence!
“Alice laughed: “There’s no use trying,” she said; “one can’t believe impossible things.”
“I daresay you haven’t had much practice,” said the Queen. “When I was younger, I always did it for half an hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.”
-Alice in Wonderland
For thousands of years, thousands, the debtor paid interest to the lender to get money. Now we face a totally new paradigm where get debtor gets interest for borrowing money. It is crazy. It is nuts. It is unbelievable, really, but it is where we are in the present cycle.
The United States currently has the best economy, and the largest economy, and the most liquid bond markets, of any major nation on Earth. Yet, with the exception of Greece, which is only 10 bps higher, the highest yield for its 10-year debt. Just unreal!!!
At first blush it is because the world’s central banks are manipulating the debt by creating money from nothing, but keystrokes, and buying bonds with it. Yet our thinking needs to go further, much further. These central banks represent nations, countries, and most of the world’s central banks aren’t anywhere close to being as “Independent” as the Fed. They are much more controlled by their governments, so it must be said, be “Realized,” which will be difficult for some of you, that Germany, France, Switzerland, Japan, and the rest, are manipulating their interest rates for their own benefit while, at the same time, it is to the detriment of the United States and it is affecting the currencies as well.
In my opinion, President Trump has the right, if not the obligation, to object to what the Fed is doing as the Fed was created, and the policies implemented, by several Acts of Congress. Yet, in my view, American politics is not the primary instigator here, as the Fed “does” have the power to make its own “Independent” decisions. Europe and Japan are the main culprits, as I said, in the drive to ever lower and lower interest rates as they cannot afford their governmental budgets. The problem here, as I see it, is that there is no end in sight, because they can’t afford anything else.
Then, you have to ask yourself what all of this means. I have been pondering this question for months now and I have finally reached a few conclusions. First, it means that U.S. interest rates are heading lower from here, as the United States has to compete with all of these other nations and while the Fed may call it “uncertainty,” I call it “governmental intervention” on a scale never before seen in history. Creating money from nothing allows anything to be afforded and since the markets are now global, the Fed is going to get pushed, “forced,” by the other central banks, and the nations they represent, into lowering our rates further to protect American interests. We are now in a “Nightmare Scenario,” in my estimation, and the Fed, as America’s central bank, not the world’s central bank, will have no choice except to keep lowering rates as well, just to maintain America’s position.
So, it is going to be lower and lower yields for everything, which will help the costs of America’s governmental borrowing along with corporate borrowing, mortgage rates, student loan debt and borrowing by individuals. That is the plus side, as we get “forced” to go along. The negative side is that savers, and pension funds, and the like, are in the “Big Squeeze.” Pew Charitable Trusts states that the median pension fund assumption, for the State Pension Funds in the United States, is 7.50%. Well, with the Bloomberg Treasury Index yielding 2.00% and the Bloomberg American Corporate Index yielding 3.20% and the Bloomberg American High Yield Index yielding 5.84% you begin to realize that bonds, for the pension funds, have become non-starters. They are losing investments from the “get-go,” to achieve their median pension fund assumption.
Around the next bend, you then realize that Real Estate and the equity markets are going to go up and UP in price. This is because so much money will get forced into them, as so much money gets forced out of bonds. Then you also have to come to grips with the fact that some State and corporate pension funds are likely to be forced into bankruptcy, as mistakes are made, and as their median assumptions probably cannot be obtained in any market.
So, there you have it, boatloads of cash created form nothing, interest rates going down, Equities up, Real Estate up, Bond yields down, and all because the world’s central banks have done the “impossible.” They thought negative yields were impossible, everyone thought they were impossible. They learned they were possible. Now they are continuing on with their programs, as the ECB is about to start a new Quantitative Easing plan, and America will have no choice except to follow along. Just watch!
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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.
Redistribution/reproduction of this material is prohibited. See additional disclosures at: http://brileyfbr.com/legal/legal_disclosures