Out of the Box: The Bond Markets — Fast and Furious
America is under assault. While almost everyone is concentrating on the trade dispute between the United States and China, I am on a different course. I am focusing on what the nations in the European Union, Switzerland and Japan are doing by promoting negative yielding debt that now exceeds $14.1 trillion, and is expanding daily. The value of bonds yielding less than Zero now makes up more than a quarter of the entire investment-grade market, the data shows. This sub-Zero debt comprises 25.68% of the Bloomberg Barclays Global Aggregate Index, a gauge which includes government, corporate and securitized debt.
In the known history of the world we have never seen anything like this. “Different This Time,” does not begin to rationally assess what is going on here. Never, in recorded history, has this phenomenon taken place and, in my opinion, it is going to shake the bond markets, to its core, for years, if not decades. An earthquake is taking place and while some nod at what is in process, most do not have an adequate understanding of just what is taking place, or the very serious implications for the markets or the global economies.
The base case here is that the nations of the European Union, Switzerland and Japan can no longer afford their budgets, or their social programs, or various EU expenditures without raising taxes and causing upheaval in many governments and in the European Union, itself. This means that the nations in the EU, are basically insolvent, and are only hanging on by the use of the “Manufactured Money” from their central bank. They make the money, they buy sovereign and corporate bonds, drive yields to less than nothing which allows their governments, and the European corporations, to borrow money for next to nothing, nothing, or less than nothing.
I point out that they are doing this, because they can’t afford anything else. This is the key point that must be understood. They have no other rational choice, except to raid their central bank’s cookie jar, because they are all but broke, regardless of any claims made to the contrary.
In the meantime, this same course of action also pushes the Dollar to higher levels against the Euro and the Swiss and Japanese currency. I long predicted a Dollar break-out from the 1.12 to 1.14 range and now, at 1.1097 this morning, according to Bloomberg data, I am forecasting a break down to 1.08, in the not too distant future, for the Dollar/Euro valuation. The Barbarians are at the gates.
Rationally, the American bond market has now broken out of its range and the 10-year Treasury is now on a path to a 1.70% in my estimation. I have done the technical work and that is where I think it is headed as forced, literally forced, by the machinations of the countries in the European Union, Switzerland and Japan. The Bloomberg Euro-Aggregate bond yield now stands at 0.068% while the Bloomberg Asian-Aggregate bond yield is 0.606%, which leaves Treasuries plenty of running room to catch up.
The reality of all of this is that borrowers are standing in Heaven and Investors are standing in Hell. I foresee a massive amount of bond buy-backs, tenders, re-financings, equity buy-backs, as America, with the rest of the world leading the way, heads towards Zero, and less than Zero, yields. Some have said that it can’t happen here and to that I say, “Baloney.” The United States is now caught in a trap created by Europe and Japan and there is just no way out, for the foreseeable future, without bankrupting those nations and causing a financial upheaval that would make the Great Recession look like a minuscule event.
In the first instance, lower and lower rates will be a net positive for the equity markets, for Real Estate, for REIT’s, for mortgages, for corporate earnings, as financing costs minimize, and for any other type of corporate or individual borrowing. In the second instance, when lower rates no longer move the needle, and assets aren’t inflated by lower rates, you may expect market turmoil as various bubbles inflate and then burst.
The summation here, in my view, will force the Fed to keep lowering rates so that America can remain competitive with the rest of the world. They will have absolutely no choice, regardless of the recent remarks from Chairman Powell. Just wait until September, when Mr. Draghi, at the European Central Bank, fires off his next and last salvo, before leaving as head of the bank. I am expecting some sort of “Shock and Awe” announcement from him where the ECB expands their next round of Quantitative Easing they may even include, along with Switzerland and Japan, the buying of equities.
All of this, for investors in the United States, is going to wreak havoc on pension funds, insurance companies, people living on fixed incomes, retirees, and any institution, or person, that depends on their savings to maintain their lifestyles. First, there will be a giant hunt for yield that will make the “Hunt for Red October” look like child’s play. Anything, everything, that provides some sort of decent cash flows will be bought up, as American yields head lower and lower and lower. It will also force many people and corporations into making much riskier bets that will eventually lead to blow ups.
Alice: “Why, they’re only a pack of cards.”
Prepare yourself for the re-shuffle. “Preservation of Capital” rules.
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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