Today it is time for a journey into what is an old stomping ground of mine which is bond markets. Actually reminders of such things have been about because this week has been the 30th anniversary of the “Big Bang” in the UK which I just made. Let me immediately point out that those 30 years have been an extraordinary bull market for bonds although there have of course been ebbs and flows. It should be a sobering thought for the latter-day central planners at the central banks that prices were rising and yields falling way before they enacted extraordinary monetary policies and QE (Quantitative Easing). However I will throw in one morsel which is that you could argue that the era of inflation targeting by central banks has turned out to be a very good one for bond investors. Frankly beyond most of their dreams. But to quote out new Nobel Lauriet Bob Dylan there are concerns that.
The Times They Are A-Changin’
A Step Back In Time
We only have to go back a few days or so to see an example of a group of investors looking to continue to front run a central bank, in this case the ECB (European Central Bank). From the Financial Times.
This week Austria sold government debt that will not mature until 2086 — highlighting the risk investors are willing to run for positive yields.
Well played to the Austrian taxpayer who saw this happen on their behalf according to Bloomberg.
The nation sold 2 billion euros ($2.2 billion) of the bunds this week, taking advantage of historically low borrowing costs.
How is that going?
A buyer of 10 million euros of the securities saw a paper loss of more than 500,000 euros by the end of Thursday, according to data compiled by Bloomberg.
As a short-term trade this has turned out to be appalling as you see it will take more than 3 years at the original yield of 1.53% to get that back or if we get a little more technical investors have felt the whiplash of what is called duration.
Its relatively low coupon and long maturity help produce a high duration factor, meaning it’s price is more volatile.
Now market prices change but as we stand the Austrian taxpayer has played a stormer here and they have not been alone.
Before Austria’s 70-year offering, Italy, France, Belgium and Spain had sold half-century debt this year in syndicated deals — which are co-ordinated by banks.
The UK has in fact a history in this area and sold a 39 year Gilt in August and has had several goes at a 30 year one both this month and last. In fact around 4 years ago I was interviewed on Russia Today about a possible 100 year Gilt which seemed cheap then (for taxpayers) and would be even cheaper now.
This from the FT shows how brains have been scrambled by what has been taking place.
Luke Hickmore at Aberdeen Asset Management says the prices for long-dated debt look “shocking, yet at the same time they still make sense in the current environment”.
Another perspective has just been sent to me on Twitter from John Murray about the 70 year Austrian bonds.
How long’s a lifetime?
What has changed?
This returns me to my subject of Wednesday which was on the rising trajectory for inflation ( oh and if I may be so bold I did point out what a bad deal that Austrian bond was). If we stick with the inflation issue take a look at this from Germany this morning.
Now this is only a relatively minor amount of inflation but if you wished to match it to your yield then you would have to buy a thirty-year bond. Those with bonds up to the nine-year maturity would be facing negative yields as well as the inflation.
There have been various hints of looser fiscal policy around the world. Perhaps the clearest has come from Japan where Prime Minister Abe has launched yet another stimulus although as ever some of it was in fact pre-existing. Also the UK seems to be heading that way if the latest public finances numbers were any sort of guide. The IMF started its campaign in April 2015.
fiscal policy can contribute substantially to macroeconomic stability, through the workings of automatic stabilizers. By doing so, fiscal policy can also unlock significant growth dividends.
Hard to believe that in the Euro area it did exactly the reverse isn’t it? My advice is never to buy any tyres or brakes from the IMF as the screeching U-Turns will have damaged them.
These have of course fed the most recent stage of the bond market boom with their interest-rate cuts and indeed their bond buying for which they invented a long impressive sounding name, Quantitative Easing. As of the end of last week the ECB for example had spent some 1.3 trillion Euros on buying the sovereign bonds of its constituent nations and the buyers of the 70 year Austrian bond no doubt had their eye on additions to the 27.9 billion Euros spent on Austrian bonds.
Now though we see that those trying to front-run such purchases are facing issues such as the supposed ECB Taper where fewer bonds would be purchased going forwards. Also the Bank of Japan seems to be replacing action with ever more rhetoric and open mouth operations. Even the Bank of England faces the issue of claiming a “sledgehammer” is appropriate for an economy which has just seen quarterly growth of 0.5% as opposed to what it told us in August.
Their current levels, if sustained, would be consistent with a contraction in output in Q3
This has led to concerns that there will be less QE and hence fewer opportunities to front-run central banks. This has been added to by the US Federal Reserve repeating its regular routine from 2016 of claiming that a second interest-rate increase is just around the corner, the same corner it has been just around since last December! We will find out a little more on that front perhaps when we get the new GDP report later.
The simple fact is that central banks have driven sovereign bond markets to completely the wrong set of prices and created a false market. This has dangers in addition to the obvious one as they have broken the economic signals and links that used to be at play. It has added to the junkie style culture where we need ever large doses of the “medicine” but the fact we regularly need another hit provides its own critique.
In my opinion they are presently trying to address this by providing a head fake. The ECB with its taper rumours and the Bank of Japan with its new strategy want yields higher for a bit. Then they will follow the model set out by the Swedish Riksbank yesterday.
Prior to the monetary policy meeting in December, the Executive Board is prepared to extend the purchases of government bonds……..The repo‐rate path now also reflects a greater probability that the rate could be cut further.
In other words they are still singing along to Trouble by Coldplay.
Oh, no, what’s this?
A spider web, and I’m caught in the middle,
So I turned to run,
The thought of all the stupid things I’ve done,
And I never meant to cause you trouble,
And I never meant to do you wrong,
And I, well, if I ever caused you trouble,
Oh no, I never meant to do you harm.
So whilst buyers of that 70 year Austrian bond exposed their investors to a barrel load of risk they may yet be bailed out by ever more QE. At which point the Jedi Mind Tricks of the central bankers will be exposed.