The Great Bond Conundrum



Fears of a global recession this year have kept the bond markets incredibly well supported. Indeed, so much so that yields in many countries have continued to fall further intonegative territory. The amount of government bonds now offering a less than zero yield has increased steadily by the trillion as the year has progressed. At the same equity marketsgenerally speaking have risen. That is a logical default outcome- lower, or even negative rates make equity yields evermore attractive.


Perhaps and perversely though; the best stock market returns have been seen in a place where bond yields were actually rising at the same time, for much of the early part of the year, as the US Fed continued on their tightening path. That US stock market rally has been further underpinned by the Fed now walking back on their tightening cycle. More recently, mounting fears of a slowdown have not yet stunted the appetite for stocks.  That’s not to say it won’t happen, its just that there’s not yet enough evidence to suggest there’s a really significant economic downturn coming.


By the way, the other week some short term Greek government bonds actually offered a negative yield which is simply astounding quite honestly. Anyway, moving on. Japan has enjoyed flat to negative yields for decades now. I say enjoyed, but that surely only applies to the Japanese government, who have seen the funding cost of their debt now drop below zero. A great deal if that debt is subsequently being repaid.


The trouble is that it is not, and certainly not in Japan’s case.The truth is that certain governments have simply not taken advantage of this repayment window opportunity that negative rates has presented to them. Instead, they have merely added to their debt pile and then sought to screw their citizens (or anyone else foolish enough to invest at a cost) forthe so called safety of their credit rating.  The other thing to note about all this; is that negative rates are killing the banks, especially in Europe where they are forced to hold increased excess reserves and then pay for the privilege.


The great thinkers of the financial world thought that QE was the answer to the financial crisis and perhaps it was. Unfortunately, what they probably didn’t realise was that in financial terms; it’s as addictive as heroin and like that drug; long term use will normally end in disaster. Let’s not forget that QE started in Japan and guess what? Thirty years later they are still stuck with it and meantime what has happened to the Japanese economy? Growth has been negligible for most of that period. Far from consumers splashing cheap money around the shopping malls, the opposite has actually happened.


They psychological impact of government policy has meant the Japanese consumers, for most of that period, have assumed that things are bad because interest rates are so low. Hence, paradoxically they have hoarded and saved even more. The same effect is playing out in Europe now too. However, thankfully I think the Fed realised this and that’s why theydecided to act last year. Sadly, the big burke in overall chargedoesn’t get it, but then again he sees most things in very simplistic of ways. Granted, sometimes that can be the right approach, but in less binary issues such as this, it most certainly is not.


So, the problem now is trying to figure out what will happen next? For example, how do the central bankers keep the bond and equity markets in perpetual uplift? Well, clearly at some point the bond market is going to end in tears and when that happens the equity markets will be crying just as much initially too.


However, looking around for someone to tell youthat the party is over; is extremely difficult because the place is packed and very noisy. I have spoken to countless people that want to catch the first bus, not the last, or worse still, miss a ride home altogether.

Whilst not many see it; the one thing that could certainly sink the bond markets would be a sudden bout of growth and inflation. The problem is; that is equally hard to see happening in the current environment, where saving the planet seems totally at odds with growing our way out of stasis.


So, we watch and we wait for developments to unfold, but in the meantime it’s surely tough to know where to stash your cash. That’s one of the major reasons why gold has had such a good run this year, especially against the pound. However, that might just be turning now, assuming something good happens on the Brexit front this week. Right at this minute the signs are increasingly encouraging, but as ever; ‘nothing is agreed until everything is agreed.’



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