Out of the Box: Paving, with Good Intentions
“The Road to Hell is Paved with Good Intentions.”
-Saint Bernard of Clairvaux (1090–1153)
There is no question, really, that we are slipping further, and further, down the rabbit hole. The amount of Negative yielding bonds was $12.2 trillion in 2016. A few weeks ago, we had $13 trillion of them, and then the total was $15 trillion, then $16 trillion, and now we are over $17 trillion, in just a few weeks’ time. The pace is frankly astonishing!
The expansion, of the universe of negatively yielding bonds, is now around 30.0% of the world’s total amount of bonds. This is as compared to the 2016 high of 25.8%. Just wrap that around your mind. Something, once though impossible, is now not only possible but of such a scope, and size, that it is getting frightening and likely will get more frightening still.
The JPM Government Bond Index (8/15/19):
|NATION||1-3 YRS.||7-10 YRS.||15+ YRS.|
*Data provide by J.P. Morgan
As I have pointed out before, the United States is under siege from Europe and Japan. The reason they are using “Pixie Dust Money,” created by their central banks, to buy their own sovereign and corporate debt, is because their budgets and social programs can no longer be afforded.
They have found the “Wonderland” escape hatch, however, and they are using it ferociously. No raising of taxes. No selling off assets.
No increasing their national debt. Just “Money for Nothing” and the checks are free, all created by a few keystrokes, at the central banks.
The collateral damage here, though, is that they are putting intense pressure on the Fed to respond, and protect American interests. Ultimately, I think, that both Japan and the European Union are going to damage their currencies but both people, and institutions, have not figured out exactly what is going on yet but I believe the reality will dawn on everyone, at some point, and then a different kind of carnage will set it.
Almost regardless of what the Fed does decide, though, American yields are heading lower as both Asia, and Europe, buys up American bonds as almost the only bonds left with any positive yields. “Who wudda thunk,” the largest economy in the world, still a growing economy, the most liquid bond market in the world, and we have about the highest yields in the world. In fact, according to JPM, the United States’ share of positively yielding bonds is now 94% of all positive yielding bonds that are outstanding.
“Curiouser and Curiouser!”
JPM also states, in a research report, “There is little doubt that negative yields are causing a distortion in the pricing of duration and credit risk as pension funds and insurance companies are forced to move further up the maturity and credit curve to avoid negative yields. Government yield curves and credit spread curves are losing their information content. The fact that the 3m/10y or 2y/10y UST spreads have inverted is less of a reflection of U.S. recession risks and more of a reflection of the desperation for yield by foreign investors flocking into USD denominated bonds as bond yields turned more negative in Europe and Japan.”
All of this is a great time for borrowers, of any sort, and it will be a positive for a number of markets, “initially.” This would include equities, as people scramble for any sort of return, and Real Estate, as lower borrowing costs spur investments. The lower rates will also cause insurance companies, and pension funds, to head out into Private Equity, and other alternative investments, as bond yields no longer cover their expenses, much less allow for any profits. However, that is just at the beginning, and one part, of this process.
While it is a great time to be a borrower, it is a lousy time to be a fixed-income investor. No yields, no returns, no cash flows in sight. For seniors, for retirees, for any person, or company, living on fixed-income returns, the current environment is a disaster. It may even get to the point where the U.S. government will have to raise social security pay-outs to help compensate for part, of what I believe, is going to be an extremely serious problem.
This environment, also, is going to make it very difficult for the banks, for Wall Street firms, for mortgage companies and for other entities in the financial sector. This is a two-step process, you see, and the second part will be much tougher. When American yields are at Zero, or just off Zero, on one side or the other, lower rates will no longer move the needle for buoying assets, of any type. When we get here, to quote John Smith’s, “A Sea Grammar” (1627), it is going to be “Anchors Aweigh.”
Batten down the hatches!
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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