Bubbles In Bond Land — A Central Bank Made Mania


I am in the throes of finishing a book on the upheaval represented by the Trump candidacy and movement. It is an exploration of how 30 years of Bubble Finance policies at the Fed, feckless interventions abroad and mushrooming Big government and debt at home have brought America to its current ruinous condition.

It also delves into the good and bad of the Trump campaign and platform and outlines a more consistent way forward based on free markets, fiscal rectitude, sound money, constitutional liberty, non-intervention abroad, minimalist government at home and decentralized political rule.

In order to complete the manuscript on a timely basis, I will not be doing daily posts for the next week or two. Instead, I will post excerpts from the book that crystalize its key themes and which also relate to the on-going gong show in the presidential campaigns and in the financial and economic arenas. Another of these is included below.

I am also working with my partners at Agora Financial on a new version of Contra Corner. More information on that will be coming later this month.

Trumped Final


…..Sometimes an apt juxtaposition is worth a thousand words, and here’s one that surely fits the bill.

Last year Japan lost another 272,000 of its population as it marched resolutely toward its destiny as the world’s first bankrupt old age colony. At the same time, the return on Japan’s 40-year bond during the first six months of 2016 has been an astonishing 48%.

That’s right!

We aren’t talking Tesla, the biotech index or Facebook. To the contrary, like the rest of the Japanese yield curve, this bond has no yield and no prospect of repayment.

But that doesn’t matter because it’s not really a sovereign bond anymore. These Japanese government’s bonds (JGBs) have actually morphed into risk free gambling chips.

Front-running speculators are scooping up whatever odds and sots of JGB’s that remain on the market and are selling them to the Bank of Japan (BOJ) at higher and higher and higher prices.

At the same time, these punters face virtually no risk. The BOJ already owns 426 trillion yen of JGB’s, which is nearly half of the outstandings. And that’s saying something, given that Japan has more than one quadrillion yen of government debt which amounts to 230% of GDP.

Moreover, it is scarfing up the rest at a rate of 80 trillion yen per year under current policy, while giving every indication of sharply stepping-up its purchase rate as it segues to outright helicopter money.

It can therefore be well and truly said that the BOJ is the ultimate roach motel. At length, virtually every scrap of Japan’s gargantuan public debt will go marching into its vaults never to return, and at “whatever it takes” in terms of bond prices to meet the BOJ’s lunatic quotas.

The Big Fat Bid Of The World’s Central Banks

Surely, BOJ Governor Kuroda will go down in history as the most foolish central banker of all-time. But in the interim the man is contributing—-along with Draghi, Yellen and the rest of the central bankers’ guild—-to absolute mayhem in the global fixed income market.

The effect of their massive bond purchases or so-called QE policies has been to radically inflate sovereign bond prices. The Big Fat Bid of central bankers in the benchmark government securities sector, in turn, has caused drastic mispricing to migrate into the balance of the fixed income spectrum via spread pricing off the benchmarks, and from there into markets for converts, equities and everything else.

Above all else, the QE driven falsification of bond prices means that central banks have supplanted real money savers as the marginal source of demand in the government bond markets. But by their very ideology and function, central bankers are rigidly and even fiercely price inelastic.

For example, the madman Draghi will pay any price—-absolutely any price—–to acquire his $90 billion per month QE quota. He sets the price on the margin, and at present that happens to be a yield no lower than negative 0.4% for a Eurozone government security of any maturity. Presumably that would include a 500-year bond if the Portuguese were alert enough to issue one.

Needless to say, no rational saver anywhere on the planet would “invest” in the German 10-year bund at its recent negative 20 bps of yield. The operational word here is “saver” as distinguished from the hordes of leveraged speculators (on repo) who are more than happy to buy radically over-priced German bunds today.

After all, they know the madmen at the ECB stand ready to buy them back at an even higher price tomorrow.

Yet when you replace savers with central bankers at the very heart of the financial price discovery process in the benchmark bond markets, the system eventually goes tilt. You go upside down.

The Fiscal Equivalent Of A Unicorn—–“Scarcity” In Sovereign Debt Markets

That condition was aptly described in a recent Wall Street Journal piece about a new development in sovereign debt markets which absolutely defies human nature and the fundamental dynamics of modern welfare state democracies.

To wit, modern governments can seemingly never issue enough debt. This is due to the cost of their massive entitlement constituencies, special interest racketeers of every stripe and the prevalence of Keynesian-style rationalizations for not extracting from taxpayers the full measure of what politicians are inclined to spend.

Notwithstanding that endemic condition, however, there is now a rapidly growing “scarcity” of government debt—-the equivalent of a fiscal unicorn. As the WSJ noted:

A buying spree by central banks is reducing the availability of government debt for other buyers and intensifying the bidding wars that break out when investors get jittery, driving prices higher and yields lower. The yield on the benchmark 10-year Treasury note hit a record low Wednesday.

“The scarcity factor is there but it really becomes palpable during periods of stress when yields immediately collapse,’’ he said. ”You may be shut out of the bond market just when you need it the most.’’

Owing to this utterly insensible “scarcity”, central banks and speculators together have driven the yield on nearly $13 trillion of government debt—or nearly 30% of total outstandings on the planet—into the subzero zone. This includes more than $1 trillion each of German and French government debt and nearly $8 trillion of Japanese government debt.

Nor is that the extent of the subzero lunacy. The Swiss yield curve is negative all the way out to 48 years, where recently the bond actually traded at -0.0082%.

So we do mean that the systematic falsification of financial prices is the sum and substance of what contemporary central banks do.

Forty years from now, for example, Japan’s retirement colony will be bigger than its labor force, and its fiscal and monetary system will have crashed long before. Yet the 10-year JCB traded at negative 27 bps recently while the 40-year bond yielded a scant 6 basis points!

When it comes to government debt, therefore, it can be well and truly said that “price discovery” is dead and gone. Japan is only the leading edge, but the trend is absolutely clear. The price of  sovereign debt is where central banks peg it, not even remotely where real money savers and investors would buy it.

The world is even poorer ... In yield terms...after Brexit

Still, that’s only half the story, and not even the most destructive part. The truth of the matter is that the overwhelming share of government debt is no longer owned by real money savers at all. It is owned by central banks, sovereign wealth funds and leveraged speculators.

As to the latter, do not mistake the repo-style funding deployed by speculators with genuine savings. To the contrary, their purchasing power comes purely from credit (repo) extracted from the value of bond collateral, which, in turn, is being driven ever higher by the Big Fat Bid of central banks.

What this means is that real money savings—– which must have a positive nominal yield—-are being driven to the far end of the sovereign yield curve in search of returns, but most especially ever deeper into the corporate credit risk zone in quest of the same.

The Pure Lunacy Of Mario Draghi

Nowhere is the irrational stampede for yield more evident than in the European bond markets. After $90 billion per month of QE purchases by the ECB, European bond markets have been reduced to a heap of raging  financial market lunacy.

It seems that Ireland has now broken into the negative interest rate club, investment grade multinationals are flocking to issue 1% debt on the euro-bond markets and, if yield is your thing, you can get all of 3.50% on the Merrill Lynch euro junk bond index.

That’s right. You can stick your head into a veritable financial meat grinder and what you get for the hazard is essentially pocket change after inflation and taxes.

Remember, the average maturity for junk bonds is in the range of 7-8 years. During the last ten years Europe’s CPI averaged 2.0% and even during the last three deflationary years the CPI ex-energy averaged 1.2%.

So unless you think oil prices are going down forever or that the money printers of the world have abolished inflation once and for all, the real after-tax return on euro junk has now been reduced to something less than a whole number. It might be wondered, therefore, whether the reckless stretch for “yield” has come down to return free risk?

Well, no it hasn’t. Yield is apparently for desperate bond managers and other suckers.

In fact, among the speculators who wear big boy pants the bond markets are all about capital gains and playing momo games. It’s why euro junk debt—-along with every other kind of sovereign and investment grade debt—-is soaring. In a word, bond prices are going up because bond prices are going up. It’s an utterly irrational speculative mania that would do the Dutch tulip bulb punters proud.

In the days shortly before Draghi issued his “whatever it takes” ukase, for instance, the Merrill Lynch euro high yield index was trading at 11.5%. So speculators who bought the index then have made a cool 230% gain if they were old-fashioned enough to actually buy the bonds with cash.

And they are laughing all the way to their estates in the South of France if their friendly prime broker had arranged to hock them in the repo market even before payment was due. In that case, they’re in the 1000% club and just plain giddy.

BofA Merrill Euro High Yield Index 2016

Does Mario Draghi have a clue that he is destroying price discovery completely? Do the purported adults who run the ECB not see that the entire $20 trillion European bond market is flying blind without any heed to honest price signals and risk considerations at all?

Worse still, do they have an inkling that the soaring price of debt securities has absolutely nothing to do with their macroeconomic mumbo jumbo about “deflation” and “low-flation”?  Or that they are in the midst of a financial mania, not a ” weak rate environment” due to the allegedly “slack” demand for credit in the business and household sectors?

In fact, European financial markets are being stampeded by a herd of front runners who listen to Draghi reassure them on a regular basis that come hell or high water, the ECB will buy every qualifying bond in sight at a rate of $90 billion per month until March 2017. Full stop.

Never before has an agency of the state so baldy promised speculators literally trillions in windfall gains by the simple act of buying today what Draghi promises he will be buying tomorrow.

And that will be some tomorrow. As more and more sovereign debt sinks into the netherworld of negative yield and falls below the ECB’s floor (-0.4%), there will be less supply eligible for purchase from among the outstanding debt of each nation in the ECB’s capital key.

This is price fixing with a vengeance. It is no wonder that repo rates recently have plunged into negative territory.

But here’s the thing. The geniuses at the ECB are not cornering the market; they are being cornered by the speculators who are recklessly front-running the central bank with their trigger finger on the sell button.

Everything in the European fixed income market—sovereign and corporate—– is now so wildly over-priced and disconnected from reality that the clueless fools in Frankfurt dare not stop. They dare not even evince a nuance of a doubt.

So this is a house of cards like no other. Greece remains a hair from the ejection seat, yet everything is priced as if there is no “redenomination” risk.

Likewise, with the European economies still dead in the water, and notwithstanding some short-term data squiggles in the sub-basement of historic trends, the debt of Europe’s mostly bankrupt states is priced as if there is no credit risk anywhere on the continent outside of Greece.

Well then,  just consider three fundamentals that scream out danger ahead. Namely, public debt ratios continue to rise, GDP continues to flat-line, and the Eurozone superstate in Brussels continues to kick the can and bury its member states in bailout commitments that would instantly result in political insurrection in Germany, France and every other major European polity were they ever to be called……