It was just yesterday when we warned of a “bond bloodbath” in the event central banks ever take the proverbial plunge and attempt to normalize policy.
Specifically, we brought you the following graph from Goldman which shows you the extent of the damage should yields mean revert:
(Chart: Goldman)
As you can see, that’s a pretty ugly picture. Sometimes it feels like investors don’t have a good understanding of what happens when you buy an overpriced bond and then yields subsequently rise. But they may be about to find out.
It’s pretty rare, but occasionally CNBC will have a good article or two on their site. Today, they ran a piece called “Sell, sell, sell as monetary policy is a dead duck,” in which they quote Stephen Isaacs, chairman of the investment committee at Alvine Capital (he also used to run fixed income trading and syndication at Credit Suisse). Here’s what Isaacs had to say:
"I think monetary policy is a dead duck and I think bond yields at this level for investors represent absolutely no value and a huge amount of risk. What I would like to focus on is the coming fiscal reflationary trade because I think that is creeping out of the woodwork in many places.”
Essentially, Isaacs is arguing that the passing of the baton from monetary to fiscal policy will lead to the issuance of mountains of government debt. The glut should drive yields up and then... well… refer to the chart above.
"I would sell all the gilts I had to the Bank of England,” he adds.
That’s an interesting comment because as you’ll recall from Tuesday, the Bank of England couldn’t find enough willing sellers of longer-term bonds. We documented the “failure to launch” here.
One of the amusing things about the failed reverse auction was that paradoxically, the BoE still managed to achieve what it was after. The fact that there weren’t enough willing sellers of course caused yields to fall which is the whole point of buying the bonds in the first place. Here’s how Bloomberg put it earlier today:
“The good news is that while the Bank of England failed to actualize itself as a real buyer of 1.17 billion pounds of longer-dated paper, it proved to be a very successful theoretic alone thanks to the same mechanics that arguably limited its ability to wrest away securities from unwilling investors. ‘Because of the supposed possible scarcity now on long term gilts, yields are falling another 4.5 basis points to just .54 percent,’ noted Boockvar ahead of today's successful sale.”
“So you can't always get what you want. But if you try, sometimes you just might find you get what you need — in this case, lower borrowing costs through a flattening of the U.K. yield curve.”
(Chart: Bloomberg)
Ironic, right? Well the BoE went shopping again on Wednesday and some folks were taking the aforementioned Stephen Isaacs’ advice because this time around the operation was fully covered leading to a quick jump in gilt yields although they’ve since come back in.
Goldman is also a believer in the narrative that fiscal stimulus may be about to catalyze a sharp increase in yields. Here’s what the bank had to say earlier this week:
“Patience around QE may be starting to wear thin and focus is shifting to fiscal stimulus: Even as $10+ trillion has been spent globally since 2008, nominal GDP growth has held steady in the 3% range. Countries have been steadfast in their desire to show fiscal restraint...until now. It may be telling that the Japanese 10Y jumped 25 bp since July 27th following the announcement of a $40 bn stimulus package despite maintaining its monetary stimulus. Fiscal stimulus will likely hit a little closer to home in 2017 as both parties appear likely to pursue spending increases and/or tax increases post the US election in December.”
As for Treasury bonds, if either US presidential candidate does embark on a massive debt-funded spending spree just know that the 10Y has a long, long way to go to get back to anything that even approximates normal. As Goldman also wrote, “its current level is still extreme by historical standards - .004 percentile since 1953.”
There’s not much to like about that.
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