The bubble in bonds
It’s fair to say that while the efforts by central banks to lower not just short but long term interest rates have been successful, they have been a total disaster with regards to convincing businesses and consumers to invest and buy real assets. This is, in part, due to a dislocation in the traditional dissemination mechanism of the banks that continue to hoard capital, much to the politicians chagrin. Quantitative Easing — a measure that was first coined in Japan in the 90’s following the collapse of their real estate bubble — has had a distorting effect on long term interest rates in particular. The FED committed $1.75 trillion to a first tranche of monetary easing in 2009 and then an additional $600 billion in 2010. The BOE flooded the UK with £375 billion split over 4 years and 3 separate programs. The ECB, much more limited in terms of mandate and being influenced disproportionately by the inflation fearing Germans, avoided engaging in a clear monetary easing program having preferred to launch two long-term refinancing operations that guaranteed banks access to cheap loans. The effects of all the monetary easing to date in the wider economy remain to be seen as growth is still slow in the US, and, in fact, negative in the UK and EU. This slow economic growth thrown into the mix has been the perfect recipe for record low, never before seen yields. A direct consequence of this mix is that many savers are now in trouble, struggling to get any income from buying Gilts or Bunds, and annuity rates for pensioners have collapsed.
A Rush For Safety
Generational opportunity - the ten year trade Adding to the growth and contagion fears that have led to this unprecedented rush for “safety” has been the additional incremental buying of bonds by governments. We believe that bond prices have been artificially inflated by central bank intervention and a bubble has formed that is now in the embryonic stages of deflating. We are, in our opinion, where we were with Technology stocks on the eve on the new millennium. We all know how that ended. The case is as simple or as complicated as one wishes it to be. We prefer the simple one — everybody who could be a buyer of bonds has already bought. Think about that for a moment — central banks have expanded their balance sheets and hold debt that will, at some point, need to be returned to the market, fund managers are full to the brim with bonds, pensions legislation in the UK has forced pensions schemes to chase bonds ever higher, retail investors have been heavy buyers of bonds in recent years — where is the extra demand going to come from? The headwinds for bonds are material and include an unwinding of the central banks’ balance sheets, inflation actually making its way into the system in sync with a strengthening economy or continued monetary debasement, increased lending by banks as their own balance sheet reparations conclude over the next few years and increasing competition by equities to global fund managers (many solid stocks yield 4, 5 and 6%). In short, it is a blind man who buys bonds here — 32 years long in the tooth with the bull market.
The sovereign debt crisis in Europe has led to Greece, Ireland, and Portugal having to ask for direct financial help as they have seen yields demanded on their government debt rising to unsustainable levels. In contrast, demand for deemed “safe” government debt in the UK, US, Germany, Switzerland, Scandinavian countries, Austria and the Netherlands has seen yields dropping dramatically.
September 2012 | www.financial-spread-betting.com | 61