The bond bubble just got even bigger
EDITOR'S NOTE
First the Fed cut rates. Then Trump slapped on more tariffs. And now the yield on thirty-year German government debt has gone negative.
And nobody cares.
Seriously, where's the shock and uproar? The problem is, it's there--but in the all-too-familiar places. We've all heard the bond bears crying wolf for a decade now. And yet yields keep on sinking.
But I would suggest that something has changed over the past nine months or so. We've gone from almost achieving exit velocity on extreme central bank actions that dated back to the financial crisis, to now doubling down on them.
The amount of negative-yielding global debt--"largely isolated to the enigma of Japan until 2016," as Julian Emanual of BTIG put it--has more than doubled in that time. A quarter of sovereign and corporate debt globally now trades at negative yields, per Deutsche Bank.
The U.S. 10-year Treasury was the world's most crowded trade, according to BAML's fund manager survey, in June--before yields plunged to the 1.85% levels we're seeing today, and before everyone on Wall Street started casually talking about how 0% on the 10-year looks likely. Imagine how crowded it is now.
This week could have been the beginning of the end of the bond-buying mania. The Fed could have said the risk of fueling financial instability outweighed the economy's need for a rate cut right now. Instead, they cut rates--and said they'd stop shrinking the balance sheet two months early.
What does that mean? By not shrinking, i.e. selling bonds, they will be buying more of them to keep the balance sheet at its current size. So why not buy the 10-year at these levels? You can always sell it to the Fed! Same thing we see playing out in Europe and Japan right now.
Then came Trump's latest round of tariffs. His election--and early pro-growth, pro-business, deregulatory agenda--almost single-handedly pulled the U.S. out of a Japanification nightmare. But no longer.
As Dan Clifton of Strategas points out, "If the new proposed tariffs are implemented, the amount of tariffs will nearly offset the entire 2019 fiscal policy boost from tax cuts and fiscal spending."
The ISM survey yesterday was the ultimate insult: "back to 2016 levels." The employment component was the weakest since November 2016. New export orders the lowest since February 2016. (No wonder the 10-year is also back to 2016 levels.) And that was in the morning--before word of the new tariffs!
Here's Peter Boockvar: "I'll be blunt. The use of tariffs to achieve non-tariff-related goals [is] a colossal mistake and the negative effects are now magnifying." And that was before they were expanded! "We're going to look back on this time and say [what] were we thinking and how did we so mess up a good thing," he added.
As economist Bob Brusca points out, the president isn't trying to hurt the economy--he's trying, in the long run, to help it: "Trump's gambit on free trade may be the best bet we have to keep growth going if he can win it." If he can win it.
Let's say the U.S. absorbs the latest tariff shock and the White House gets its pro-growth mojo back. After all, the president this afternoon is expected to sign a deal that would give American beef a larger market in Europe, a sign tensions there may be thawing. The U.S.-Mexico-Canada agreement could also still get signed.
BTIG's Emanuel has a playbook if you want to bet on the bond bubble bursting: he favors U.S. and European financials and warns against utilities, software, and the 20-year Treasury bond ETF (the TLT).
But investors who have been on the wrong side of these trades for years now don't need to be reminded that markets can stay irrational longer than they can remain solvent.
See you at 1 p.m.!
Kelly
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