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“It’s Time To Say Goodbye To The Rally In Everything”
“It’s Time To Say Goodbye To The Rally In Everything”
It was nice while it lasted but the “Rally in Everything” inspired by the dovish Federal Reserve is likely coming to an end — thanks to the dovish Federal Reserve.
U.S. bonds and stocks have climbed together for most of 2019 as expectations for Fed easing led yields lower and underpinned equities.
Chair Jerome Powell threw a wrench in the works last week by actually putting the central bank on a path toward cutting interest rates.
It may be counter-intuitive, but a likely rate cut this month means long-term Treasuries are vulnerable. That’s because what the central bank ultimately wants is faster inflation, which will eat into demand for long-duration assets.
St. Louis Fed President James Bullard, who showed foresight by voting for a reduction in June, summed it up by saying he would like “to make modest moves to try to re-center inflation and inflation expectations at our 2% target.”
The 10- year TIPS break-even rates, the bond market’s measure of inflation expectations, are starting to reverse a two-month decline. Up to about 1.77% Friday from 1.62% in mid-June, they still have a way to go to get to 2%.
The June CPI report last week also seemed to vindicate Powell’s earlier assessment that some of the recent slowdown in inflation was transitory — the core rate of 2.1% matched the highest this year.
The Fed will likely be easing at a time when the broader economy, though slowing, is still chugging along. As Atlanta Fed President Raphael Bostic said “the aggregate numbers look pretty good.”
Long bonds, those most sensitive to inflation, are already suffering. A 30-year Treasury sale last week was a flop and yields rose to the highest since May. Meanwhile, the S&P 500 and Dow Jones Industrial Average both set record highs last week.
Stocks and bonds are beginning to move out of sync — look for the decoupling to continue.
Louis Gave On Corporate Debt And The Next Liquidity Crisis
This has been a good year for the stock market so far, at least in the U.S., yet many investors are wondering when the other shoe will drop. We spoke with Louis-Vincent Gave, founding partner and CEO at Gavekal Research, about the explosion in near junk corporate debt and why this is a problem during the next economic downturn.
For audio, see Louis Gave: Bond Market Liquidity Is the New Leverage
Bond Market Liquidity Is a Problem
The situation that’s developed is concerning. With the growth of exchange-traded funds (ETFs) in the corporate bond space, we have players that are guaranteeing daily liquidity in an asset class that historically doesn’t always guarantee liquidity.
Today, if investors need liquidity in a hurry, they’re essentially on their own, Gave stated. Meaning we might notice a dislocation in corporate bonds, keeping in mind that we’ve seen record issuance.
Normally, corporate debt relative to GDP makes highs at the bottom of the cycle when GDP is shrinking and everybody’s tapping their credit lines. Corporate debt relative to GDP is extremely high, and interestingly, Gave noted, the amount of debt that’s grown the fastest is just one notch above junk.
During the next recession, the number of companies that will be downgraded will lead to forced selling by institutions. This is one of Gave’s greatest concerns today.
Source: Gluskin Sheff
Buyer of Last Resort
We’ve had a semi-crisis in emerging markets this year and U.S. bond yields have come down, which normally provides some cushion to the system. This is the first time in Gave’s career where U.S. bond yields have gone up while emerging markets were under pressure.
…click on the above link to read the rest of the article…
Bond Crash Continues – Aussie & Japan Yields Burst Higher
Bond Crash Continues – Aussie & Japan Yields Burst Higher
The carnage in Europe and US bonds is echoing on around the world as Aussie 10Y yields jump 15bps at the open (to 3.04% – the highest in 6 months) and the biggest 2-day spike in 2 years. JGBs are also jumping, breaking to new 6-month highs above 50bps once again raising the spectre of VAR-Shock-driven vicious cycles…
The spectre of a self-feeding dynamic is something we’ve discussed at length before, most notably in 2013 when volatility-induced selling — reminiscent of the 2003 JGB experience — hit the Japanese bond market again, prompting us to ask the following rhetorical question:
What happens to JGB holdings as the benchmark Japanese government bond continues trading with the volatility of a 1999 pennystock, and as more and more VaR stops are hit, forcing even more holders to dump the paper out of purely technical considerations?
The answer was this: A 100bp interest rate shock in the JGB yield curve, would cause a loss of ¥10tr for Japan’s banks.
What we described is known as a VaR shock and simply refers to what happens when a spike in volatility forces hedge funds, dealers, banks, and anyone who marks to market to quickly unwind positions as their value-at-risk exceeds pre-specified limits.
Predictably, VaR shocks offer yet another example of QE’s unintended consequences. As central bank asset purchases depress volatility, VaR sensitive investors can take larger positions — that is, when it’s volatility times position size you’re concerned about, falling volatility means you can increase the size of your position. Of course the same central bank asset purchases that suppress volatility sow the seeds for sudden spikes by sucking liquidity from the market. This means that once someone sells, things can get very ugly, very quickly.
Here’s more from JPM on the similarities between the Bund sell-off and the JGB rout that unfolded two years ago:
…click on the above link to read the rest of the article…
