I am shocked at how many market pundits focus primarily on the demand side of the equation when forecasting bond market prices. Too many look at the wall of buying from the ECB, BoJ and the other Central Banks, combined with the desperate scramble from yield starved savers like pension funds, and all they can do is extrapolate forever rising fixed income prices.
This quote from a recent Bloomberg article sums up the situation perfectly:
“The demand for income is bigger than anything I’ve ever seen before,” said Rick Rieder, global chief investment officer of fixed income at BlackRock Inc.
But whatever happened to the concept “the best cure for high prices, is high prices?”
I am not clueless enough to fail to recognize that the persistent falling of money velocity has rendered monetary stimulus increasing ineffective, but I refuse to believe it is anywhere near as impotent as widely believed.
Yields around the world have fallen to bat shit stupid levels. There is something like $13 trillion of negative yielding debt. Stop and think about that for a second. $13 trillion of bonds where the issuer is paid to borrow money.
I know the global economy is facing a demand problem, but when you price credit this cheaply, human beings will find things to do with the money. They might not be smart things, but they will borrow.
According to Bloomberg, we are already on track for a record corporate bond issuance:
Blue-chip companies have just sold more than $1 trillion of bonds for the fifth year in a row — and they got there quicker than ever.
Issuance has boomed as companies from Apple Inc. to Exxon Mobil Corp. rushed to take advantage of borrowing costs near record lows. And investors have flocked to the debt to escape $11.4 trillion of bonds elsewhere that are trading at negative yields thanks to unprecedented stimulus from central bankers outside the U.S. Investment-grade bond sales exceeded $1 trillion on Wednesday after companies including Royal Dutch Shell Plc issued more than $20 billion of bonds.
I don’t have the direct numbers, but I am reading reports of huge supply being prepared for sale now that summer holidays are over. Corporate issuers are lining up to take advantage of these dumb yield levels.
This line of thinking is hardly ground breaking. But I want to leave you with one thought regarding this summer’s bond action.
Quantitative Easing programs are by and large, designed to consistently buy bonds. Week after week, the Central Bank bids, and whatever the price, they get their blue ticket fills.
But during the summer months, trading desks empty, and more importantly, business slows to a crawl (especially this summer). These are far from ideal conditions to float big new corporate issuances, so many Treasurers simply sit on their hands.
Supply is therefore artificially reduced, yet the Central Banks don’t alter their QE buying.
What if this summer’s bond rally was exaggerated by mismatched supply and demand timing? And if so, this means that the next couple of months will see the reverse.
I am bearish on fixed income prices. Regardless of fundamentals, I think supply will weigh more heavily on the bond market than most anticipate.