Out of the Box: The Pink Flamingo in My Pool
I have decided that it is all the fault of the damn Pink Flamingo. It arrived recently, from France, and it has just been causing havoc. Equities, on Friday, got swacked, Bonds were up like gangbusters and people were fleeing for safe retreats, safe havens, safe anything, including cash. All while the Pink Flamingo floated about, in my pool.
Heaven help us.
The 10-year Treasury closed Friday at 1.54%. We are only off 18 basis points from the record low, going back to 1950, of 1.36% set on July 8, 2016, according to Bloomberg data. Comments from President Trump, no comments from President Trump, and yields are heading lower, one way, or the other. The European Central Bank, along with the Swiss National Bank, and the Bank of Japan, are forcing the Fed into a corner where it is literally “stuck in the muck.” Last week, a member of the ECB’s rate-setting committee said the market could expect fresh stimulus that should include “significant and sufficient” bond purchases and cuts to key interest rates to be announced in September. Their meeting is on September 12.
Push has come to shove and with approximately $17 trillion of negative yielding bonds, in the markets, the United States is about the last man standing with a “+” sign in front of all of its yields along the Yield Curve. Deutsche Bank’s chief economist, Torsten Sløk, recently stated that the hunt for positive returns has pushed European money managers and Japanese banks into debt issued by the U.S. Treasury and American businesses. No surprise here.
Société Générale’s Index, focused on the bond markets, has gained around 34% year-to-date. The generic 30-year Treasury bond is sitting on a 14% gain year-to-date. All U.S. Treasuries, in fact, have gained 7.15% year-to-date. Also, Merrill Lynch states that returns on Treasury debt, that matures in more than a decade, topped 20% for the first time ever, on August 20. That puts those longer-term bond gains ahead of the pace of the S&P 500 which closed Friday up about 13.57%, thus far in 2019.
Further, year-to-date, the Bloomberg U.S. Corporate Index is up 13.78% while their High Yield Index is up 10.46%. So there, Mr. equities only, how do you like them apples? It was “read ‘em and weep,” by week’s end.
Also, in the past few weeks, we have seen the universe of negative-yielding corporate bonds more than double to $1.2 trillion. U.S. corporate debt now makes up 50% of all global investment-grade corporate bonds, it should be noted. All of the American corporate yields still remain positive but they will continue to head lower, in my opinion, as European money continues to wash up on the American shores.
My observation is that the United States is currently locked into a “Game of Thrones” battle with both the European Union and with China. The European focus is on interest rates, and the Chinese focus is on tariffs. Much is made of the trade wars with China but I would assert that the conflict with the EU is every bit as important, maybe more important, though hardly discussed at all.
Here is the Fed’s take on trade:
“We have much experience in addressing typical macroeconomic developments under this framework. But fitting trade policy uncertainty into this framework is a new challenge. Setting trade policy is the business of Congress and the Administration, not that of the Fed. Our assignment is to use monetary policy to foster our statutory goals. In principle, anything that affects the outlook for employment and inflation could also affect the appropriate stance of monetary policy, and that could include uncertainty about trade policy. There are, however, no recent precedents to guide any policy response to the current situation. Moreover, while monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rule book for international trade. We can, however, try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives.”
“It will at times be appropriate for us to tilt policy one way or the other because of prominent risks.”
-Fed Chairman, Jerome Powell
Much is also made of what companies will be affected by the Chinese side of America’s “Game of Thrones.” No attention is being paid, at all, to the European side of America’s “Game of Thrones.” I’ll fill in the gap.
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. The low rate investment environment, caused by the nations in Europe directing the ECB, is also going to make it very difficult for the banks, for Wall Street firms, for mortgage companies, for insurance companies and for other entities in the financial sector. Also, how can mutual funds, money managers, of every stripe, charge their current fees when there is virtually no yield in sight. For the banks and investment banks, the problem will focus on the bid/ask spreads, when yields hit just this side of Zero, or less.
We are rockin’ and rollin’ all right, and the name of the band is “Dire Straits.”
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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