I’ll keep it short this week, mainly because I don’t have much new to say. I continue to think that the tug-of-war between markets and monetary policymakers in fixed income markets remains the key spectacle to watch, even if I concede that we have been watching it for a while. There are economists and strategists who will tell you that policymakers are perfectly happy with steepening yield curves, and that they in fact welcome them. To believe this, however, requires that you forget the initial stages of the pandemic-policy response in which central bankers solemnly pledged to print as much money as needed—via QE—to keep rates pinned across all maturities in order to support the monumental fiscal efforts needed to prevent economic disaster. If you’re telling me that this tacit agreement is now broken on the eve of the new US administration is about to shovel €1.9T into an almost fully vaccinated economy—that’s just shy of 10% of GDP for those wondering—I have to concede that yields can, and likely will, move a lot higher. But is that really what you’re telling me? It seems to me that observers have quietly pivoted towards the idea that central banks obviously accept, even want, higher bond yields to reflect the recovery. I am sorry, but that doesn’t pass the smell test. While a steepening yield curve sows the seeds of its own destruction via an ever more attractive roll and carry, especially with fwd guidance on the front end, there is always a risk that markets end up questing the commitment to low policy rates.
Read MoreFirst things first, I am GBP-based investor, which means that I need to think about both the value of currency and asset, when I dip my toe into US financial markets. With GBPUSD pushing 1.40 and the US 10y motoring bast 1.5%, I had to do something last week, and that something was to buy some duration in the US. I thought that I’d put that up front, because in what follows, I will sound like a broken record It is now getting feisty in bond-land. The sell-off in US duration got rowdy last week, and is now starting to pull up bond yields in Europe. What’s more, front-end curves are steepening too, which is to say that markets are now trying to bring forward rate hike expectations into market-relevant forecast horizons. As I have explained on these pages since the beginning of the year, investors and strategists are still debating whether this is all part of the plan—reflecting a desired increase in growth and inflation expectations—or whether it constitutes an undue tightening in financial conditions. Market observers remain undecided, partly because policymakers can’t seem to figure out where to draw the line either. Higher bond yields are good, so long as they don’t become a constraint on the recovery via a tightening of financial conditions. In principle, there is nothing wrong with this position, though it also invites the situation we now find ourselves in. Put simply, yields will motor higher until something breaks, or until policymakers call it quits.
Read MoreEverybody knows the feeling that they’re getting more than they bargained for, and I suspect we’re about to see a crack in the market narrative along those lines. Let me explain. From the point of view of those who believe the benefits of economic stimulus far outweighs its potential costs, the Covid-19 epidemic is a convenient amplifier. A strong cross-party coalition has formed in response to the crisis emitting a rallying cry for governments and central banks to throw caution to the wind and unleash an unprecedented wave of support and stimulus. Policymakers have done exactly that. The number is still going up, but somewhere along the lines of 20-to-25% of global GDP is now on tap, and that excludes the fact that central banks are, in most cases, pledging unlimited support via various liquidity and purchase programs. What’s not to like? As I have been at pains to point out in response to this benevolent consensus on the idea that because money is freely available, no one should want for anything, reality is complicated. It’s relatively easy to create liquidity. It’s much more difficult to make sure the money goes to where it is “supposed to,” and in any case, there will always be disagreement about who should get what, and how much. The current situation is a case in point.
Read MoreIt is tough to look beyond the depressing daily death dispatches from around the world detailing the tally of the Covid-19 epidemic. Yet that is exactly what investors must to do, if they want to have a fighting chance to figure out what happens next. These data are undeniably terrible, but they are known quantities for markets, even in the U.S. and the U.K., where the numbers are rising too fast for their own good. They will continue to rise, for at least a few more weeks, at least. Meanwhile in the world as a whole, two immovable objects are now crashing into each other. We can’t return our economies to normal operation due to the risk of an uncontrollable public health crisis, but equally, we can’t maintain economic lockdowns indefinitely. The circuit-breaker in the form of a coordinated monetary and fiscal stimulus program to the tune of nearly 20% of global GDP is a stop-gap solution at best. This is because that is arguably the level of GDP that developed economies are set to lose through H1 alone. Contrary to popular belief, you can’t just freeze the economy, and then re-start at zero six months later after having printed trillions of dollars. Anyone who makes claims to this effect are, in my view, getting a little too excited about the second-order effects of our present misery, which is the economic shutdown itself, and the associated open invitation to unleash the MMT experiment. Don’t get me wrong, it is the right thing to do, but as I said, it is a second-order effect.
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