Remember how a few weeks ago everyone was convinced there could never be any inflation and rates would stay low forever? Investors were piling into US fixed income because it offered such great pick up versus other low yielding sovereigns. Not only was the “smart money” betting on continued low rates, but they were so confident, they juiced returns by selling volatility around their positions to pick up yield. Here is a Bill Gross interview from last week:
In this type of environment, it’s not the buying or selling on a trading basis that produces total return, but it’s the selling of volatility around those ranges that produces a much higher yield and higher return. You have to be right on that range and if the ranges are broken you aren’t making money, but the selling of calls and puts on a range bound market is the most attractive way to make money in that type of market. That’s what Janus has been doing and that’s why we are ahead by 5.3% this year and beating stocks and beating bonds.
I have long been banging the drum of the risks lurking in the sovereign bond market. Most investors are busy looking for a bubble in stocks or other risk assets, but miss the most dangerous asset on the planet - low yielding “supposedly safe” long dated sovereigns. I find it ironic that many of these hedge fund prophets of doom decry the distortions created by the massive global Central Bank balance sheet expansion but then hide in the very asset Central Banks are buying. Huh? You are worried Central Banks are buying too many bonds, but then you recommend buying bonds to “protect” against the coming apocalypse?
Now you might say, “that’s not fair, you didn’t know Trump would be elected. This bond market decline is all because he promised to spend one trillion dollars.” Yeah, that’s kind of true. I didn’t stand in there and forecast Trump would win and bonds would collapse. But I have been arguing for quite some time the idea governments are unable to create inflation or get long rates higher is complete horseshit. Yes, Central Banks are finding it increasingly difficult to create inflation, that much is true. With the over indebted nature of the global economy, the multiplier effect of Central Bank monetary stimulus has been plunging, but that is why fiscal policy was needed.
Too many intellectuals and establishment type thinkers have convinced themselves that given the high level of global indebtedness, there is no way we can afford to spend any more. They realize that by spending what we don’t have, it will cheapen the value of money. Given many of these elite are the ones with the money, they desperately don’t want that done. They want to hold on to the status quo.
Yet the status quo is not working for the average person. The rich keep getting richer as Central Bank policies support their asset prices, but everyone else finds themselves slipping behind.
This dichotomy is why the elites keep underestimating the rise of populism. To them things are just peachy, so they are confused as to why Britain voted to leave the EU. Or why America would vote in Donald Trump.
So although I did not predict the Donald’s win, I have been arguing that eventually governments will print and spend. And why not? Central Banks have lowered rates to bat shit crazy stupid levels. The pain from low rates is causing problems in the financial system and threatening to become destabilizing on its own.
It is such an easy call that in a democracy, given the choice between suffering with low growth and high debts, or inflating away the problem, inflation will be chosen. I think the only surprise is how long the elites managed to hold it down.
Now I am aware there is much debate about whether in the long run, inflation hurts the poor or wealthy more. And I am not choosing sides about what should be done, but merely observing what will be done. We have all watched the banksters and other corporate fat cats stuff their pockets, but the people are increasingly fed up. Since 2008 the wealthy have only gotten more wealthy, while everyone else has treaded water at best.
Monetary stimulus has worsened the problem, so increased government spending was the inevitable conclusion. Although the timing was difficult to predict with accuracy, it looks like that day has finally arrived.
And much to surprise of the “no way we can create inflation nor get long rates lower” pundits, all it took was Donald Trump promising to spend a trillion dollars on infrastructure. He hasn’t even spent it yet but the bond market has figured it out. Inflation is coming.
Have a look at the 10 year inflation expectations:
The ironic part is inflation expectations were already rising before Trump. His Presidency was just the icing on the cake. The bond market had already sniffed out.
Let’s face it, the world economy is actually much stronger than all the negative Nelly’s out there want us to believe. Have a look at this terrific chart from Nordea’s Martin Enlund:
The world PMI, which is actually the JP Morgan global PMI, has been upticking for the past six months. Although US yields have been following it higher, they still has a lot of catching up to do.
And this backing up of yields is not just a US phenomenon, have a look at the German 10 year yield.
I hesitated to write this morning’s piece about the bond market action because I didn’t want to goocher it and bottom tick the move with a bearish post.
Yet I can’t help but think this is only day one of investors realizing that long term sovereign bonds are insanely over priced. I look at Enlund’s PMI chart and think it wouldn’t take much for the US 10 year to move back to 2.5%. And then I remember all the options guys like Gross have been selling in an effort to pick up yield…
The short term trader in me is scared we are due for a bounce, but the long term skeptic wonders if the real decline is still ahead of us.
Crazy old Uncle Carl is out telling everyone how when he saw the S&Ps locked limit down on the Trump election news, he left the victory party early to buy some stocks. Now I don’t begrudge Icahn’s savvy trading one bit. Good for him.
But does anyone else think it is a little hypocritical for Carl to be bragging about betting a billion dollars on stocks going higher while his website is busy warning about the coming dangers?
Seriously - go look at his website. There is a 15 minute doom and gloom video that makes you want to crawl into a bath with a plugged in radio. It’s basically the same sort of message this guy gives:
Thanks for reading,