Negative interest rates take investors into surreal territory

[Uccmal]

Following this topic. 

 

I see the US 30 year has hit 2%.  Bond traders dont expect interest rates to rise for 30 years???

 

 

[Cigarbutt]

https://www.wsj.com/articles/ecb-stimulus-package-may-beat-expectations-official-says-11565876685?mod=rsswn

 

"Mr. Rehn said he didn’t rule out a move to purchase equities under the QE program, but that would depend on the assessment of ECB staff."

It seems that pretty much everything is on the table. I understand that initial conclusions when the ECB considered easing was that they could buy anything except gold. They have instituted limits on the amount of debt they can buy (how surreally negative, % of total sovereign held for a specific country) but easing could restart on a dime and these limits could be easily modified.

 

So the question is which model of central bank equity market intervention will they adhere to?

Switzerland is in a class of its own so there seem to be two models.

 

1-The Singapore Central Bank model used in 1998 during the Asian currency crisis

Although unprecedented and ridiculed by other central authorities then, the people in charge of governance inspired their intervention on the Bagehot framework for crisis management ie buy a large amount to cause a paradigm shift, buy stuff that makes sense and prevent zombification. The Central Bank bought about 10-11% of their equity market (!) at a time when valuations were low. This was part of a concerted effort and was considered a success as the Singaporean economy and markets reverted back to their positive trajectory.

 

2-The Japan model

Well, it's a different model. Basically, the endpoint remains undefined and the central bank is becoming increasingly the only game in town.

 

Which one will the ECB choose?

 

Apologies for asking a question that suggests that the emperor has no clothes but if their 'idea' is to lower the cost of equity in order to stimulate investment and demand etc and if firms can (already and for some time) liberally borrow at negative rates and still not invest in productive capacity, then what on earth could cause firms to change their behavior in the current environment?

[TwoCitiesCapital]

Following this topic. 

 

I see the US 30 year has hit 2%.  Bond traders dont expect interest rates to rise for 30 years???

 

We'll, at least not for the next several. I doubt most incremental buyers are planning to hold for the full 30 years and are looking to the duration for speculative/hedging purposes.

 

Those who are buy/hold buyers (pensions, etc) probably have other ways of managing/mitigating the duration and inflation risk at some time in the future.

[Uccmal]

Following this topic. 

 

I see the US 30 year has hit 2%.  Bond traders dont expect interest rates to rise for 30 years???

 

We'll, at least not for the next several. I doubt most incremental buyers are planning to hold for the full 30 years and are looking to the duration for speculative/hedging purposes.

 

Those who are buy/hold buyers (pensions, etc) probably have other ways of managing/mitigating the duration and inflation risk at some time in the future.

 

Of course. 

[RuleNumberOne]

My home insurance has a value of $310 per square foot in construction cost reimbursement. E.g, if a 3000 square foot house burns down, the insurance company pays $310 x 3000 = $930,000.

 

So insurance claims and policies track real inflation (not the fake one reported by the government.) Construction costs have doubled in the Bay Area over the last 7 years from $150 to $300 per square foot.

 

Insurers need to be able to invest in stocks like Warren Buffett to keep up with the real economy. I think Berkshire gets leeway to buy stocks, but other insurers like Markel have to have 80% of their assets in bonds?

 

Property casualty insurance companies that invest in bonds are disadvantaged compared to Berkshire Hathaway if Berkshire gets to invest in stocks.

 

 

[Cigarbutt]

Following this topic. 

 

I see the US 30 year has hit 2%.  Bond traders dont expect interest rates to rise for 30 years???

We'll, at least not for the next several. I doubt most incremental buyers are planning to hold for the full 30 years and are looking to the duration for speculative/hedging purposes.

 

Those who are buy/hold buyers (pensions, etc) probably have other ways of managing/mitigating the duration and inflation risk at some time in the future.

Of course.

Investors buying the 30-yr us gov. bond 'expect' a 2% return over the life of the bond (as this is written, it is mentioned that the US contemplates 50-yr and 100-yr bonds). This 2% coupon includes 1-a real return component linked to overall growth, 2-an inflation expectations component and 3-a theoretical/conceptual/common sense component implying that the return (apart from 1- and 2-) on a 30-yr contract 'deserves' a higher yield vs a shorter term contract. So, a very strong argument, forgetting the global swath of negative interest rate bonds for a minute, could be made that this is now one of the most crowded trades in the market, perhaps in the same category as BeyondMeat or WeWork. Because, especially if one believes in cycles or reversion to the mean, the trajectory now suggests that, somehow, a lower bound will be met.

https://www.macrotrends.net/2521/30-year-treasury-bond-rate-yield-chart

 

Mr. Buffett, for decades, has often described that investing in long term risk-free bonds has been, most of the times, a significant way to lose purchasing power. Since the 70's and after, he has been worried by inflation. Berkshire Hathaway's lilliputian fixed income position is a testament to that now. However, so far, investors in risk-free long term securities have done well and the present conundrum has to do with the question of how surreal this situation can go.

 

It is interesting to note that, despite very vociferous and long-term warnings about the dangers of inflation, in 2008, in the NYTimes landmark article Buy American. I am, Mr. Buffett noted:

"So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities."

Conclusion:

Buying or holding a 30-yr bond now makes little sense from the fundamental and long-term point of view but a bottom may not have reached yet in this part of the debt cycle.

[RuleNumberOne]

The fall in the 30-year yield from 3% to 2% resulted in a capital gain of 20%.

 

If the US government issues 50 or 100-year bonds, there will be great demand from the GFT practitioners. You need to have a very evil mind to issue a 100-year bond to human beings.

 

Meanwhile the Argentina century bond has fallen 37% this month.

[RuleNumberOne]

If the US 30-year yield gets driven down to 1% by the GFT practitioners, there is a further capital gain of 26%.

 

I think we can see a 1% on US 30-year. Do you want the 26% or not? Looks like easy money to be made, doesn't it? Like the 1999 dot-com bubble....

 

[scorpioncapital]

The fall in the 30-year yield from 3% to 2% resulted in a capital gain of 20%.

 

If the US government issues 50 or 100-year bonds, there will be great demand from the GFT practitioners. You need to have a very evil mind to issue a 100-year bond to human beings.

 

Meanwhile the Argentina century bond has fallen 37% this month.

 

Indeed. I fail to see the difference between a 1% 100 year bond that gives you an 80% permanent capital loss (or rather 1% after 100 years and no doubt 100 years of much higher inflation than 1%) and a debt default.

 

 

 

 

[RuleNumberOne]

"Algos" (aka trend followers) have been driving bond prices past the stratosphere.

 

https://www.ft.com/content/85c56472-bdcb-11e9-b350-db00d509634e

 

"Yields fall as prices rise; managers who clung on to their holdings as yields tumbled below zero have reaped juicy profits.

 

Among the biggest winners are computer-driven hedge funds that try to latch on to market trends. While many human traders may question the wisdom of buying or keeping a bond that apparently offers a guaranteed loss, robot traders that monitor price moves have no such qualms.

 

GAM Systematic’s Cantab Quantitative fund has gained 36.1 per cent, according to numbers sent to investors, with the biggest gains coming from bets on falling bond yields.

 

Stockholm-based Lynx Asset Management’s main fund is up 20.7 per cent while a smaller, more leveraged fund it manages has gained 30.6 per cent, according to numbers sent to investors. Lynx has been running close to the maximum bet it is permitted on falling bond yields, said a person familiar with its positioning.

 

Some human investors “focused on fundamentals have struggled to hold on to bonds” as yields have turned negative, said Anthony Lawler, head of GAM Systematic."

 

[DTEJD1997]

Hey all:

 

The lower yields go, the fewer people are going to have pensions and stable retirements.

 

The city I live/work in is almost certainly going to have to go bankrupt eventually.  They are underfunded on their pensions.  They are even MORE underfunded on their medical/health/other benefits.

 

Of course, a huge portion of their assets are invested in bonds.

 

If you have zero or one or two percent long term bond rates, saving for retirement becomes an incredibly difficult proposition.

 

A lot of people are going to learn a very difficult lesson.

[scorpioncapital]

Aren't many retirement and pension funds running big equity portfolios? I think Canadian Pension Board and some other pension funds have large equity stakes to make up for the bond portion. Not sure if it's enough though.

[John Hjorth]

Hey all:

 

The lower yields go, the fewer people are going to have pensions and stable retirements.

 

The city I live/work in is almost certainly going to have to go bankrupt eventually.  They are underfunded on their pensions.  They are even MORE underfunded on their medical/health/other benefits.

 

Of course, a huge portion of their assets are invested in bonds.

 

If you have zero or one or two percent long term bond rates, saving for retirement becomes an incredibly difficult proposition.

 

A lot of people are going to learn a very difficult lesson.

 

I read your post based on its underlying assumptions, DTEJD1997,

 

The fact here is however, - if one loosens up from the assumptions - that there always is a solution to every issue or "problem" in this space [behavior, combined with economics]. If one understands the problem, then one also knows in which direction to look for the solution to the problem.

 

In short, it's a fight against idiocy, stupidity, ignorance, incompetence on so many levels : at law & policy makers, regulators and at the pension funds, and to some extent also at the savers. One of the properties of such an issue is also that unpleasant one, that it compounds over time - the more one is procrastinating and lingering, the worse it gets - simply because it's about returns.

 

The fact is that one needs to set the pension funds free [perhaps just less constrained] to invest where the value creation is actually taking place : In the companies all over the world.

 

We all pick our own fights. My riot against all this [and the outrageous fees related to that] has been pretty silent and is called DIY.

 

- - - o 0 o - - -

 

I feel pretty sure the well educated Danish youth won't take this BS. They aren't dumb, nor are they socialdemocrats. First in line the banks have been within the last 10 years or so - next in line will be the different kinds of pension funds. I expect lower expected forward returns will create an enormous pressure on fees, and regulation about asset allocation will be subject to review and rethinking.

[Cigarbutt]

Hey all:

 

The lower yields go, the fewer people are going to have pensions and stable retirements.

 

The city I live/work in is almost certainly going to have to go bankrupt eventually.  They are underfunded on their pensions.  They are even MORE underfunded on their medical/health/other benefits.

 

Of course, a huge portion of their assets are invested in bonds.

 

If you have zero or one or two percent long term bond rates, saving for retirement becomes an incredibly difficult proposition.

 

A lot of people are going to learn a very difficult lesson.

But...what would you do if you were the pension fund manager these days? Even the actuaries seem to be confused as they write their periodic valuation report. Don't try that on your financial calculator but the conceptual thinkers are considering using a negative discount rate for the liabilities. :o

https://www.ipe.com/pensions/pensions/briefing/discount-rates-discounting-dilemmas/10016338.article

Summary: the authors suggest that illogical and unsustainable may lose their intrinsic meaning over time. (It is a 2016 article)

 

If you're really interested, take a look at the summary or the report:

https://www.bis.org/publ/cgfs61.htm

Summary: The authors suggest that there are potential risks under the surface, when considering the impact of ultra-low or negative interest on asset-liability mismatch.

 

Maybe you wonder if these global think tanks such as the BIS simply produce a bunch of BS but looking at US corporate defined benefit pension plans and publicly 'guaranteed' pension funds, my humble take is that they have done a VERY poor job in the last 10 years as they failed to adapt to the lower for longer era AND have failed to materially increase their funding ratios during one the greatest centrally-driven asset reflation episodes in human history. I also come to the conclusion that pension funds in general, in this part of the cycle, have painted themselves in a corner by increasingly reaching for yield and that propensity to reach for yield appears to be inversely proportional to their funding ratio. ::)

 

Of course, we will come out of this discounting mess and magical thinking is also cyclical.

[SharperDingaan]

Go back to fundamentals.

The more debt in a capital structure, the more the debt behaves like equity.

 

A 100 year sovereign bond is all about maximizing the price change to a small change in YTM; it produces a bigger bang for the buck that equivalent equity does, AND gives you a CB guaranteed positive carry (interest vs dividend). MORE importantly, it makes it much more difficult for a CB to put through a subsequent rate increase ..... because if the DSIB/GSIB holding those bonds could be severely compromized, that rate increase is not going through. The result? ..... YTM's lower for longer, and higher stock markets.

 

Pension plans have very limited discetion within their FI investment allocations.

US/domestic sovereign (CB guaranteed) FI that behaves like equity is highly attractive - especially when it comes with both an implied CB 'put', and greater certainty as to the direction of future interest rates. There is also the additional benefit that bond trading profit maximizes when YTM is zero. Detering further declines into negative interest rates.

 

You and I can do nothing about Algo's - but like water flowing down a river, we CAN position ourselves to benefit from them.

Lots of rivers have hydro facilities that benefit from flow &/or height differences, nothing prevents us from doing something simllar.

 

Ultimately, one has to be a truly evil bastard to issue/use 100 year bonds. It's really an act of desperation ....

So what has occurred that requires such desperate measures ?

 

We would humbly suggest that today, we are living through the modern-day equivalent of the 1929 depression.

It would appear that while the lessons/solutions learned from 1929 may have made the depression last longer; they have also made it much more humane. Point is, expect depression era returns, NOT 'normal' returns.

 

And is that not almost exactly what we are seeing?

 

SD

 

 

[Spekulatius]

^ I very much agree with SD‘s post above for once.

+1.

 

If one had an infinite balance sheet, you could buy up the entire SPY and guarantee  a 2% payout increasing with inflation with infinite duration at its current valuation and it should be AAA rated. One could argue that it this securitized bond were default, the US would probably default as well. It’s a Gedankenexperiment, but imo a helpful one.

[SharperDingaan]

^ I very much agree with SD‘s post above for once.

+1.

 

If one had an infinite balance sheet, you could buy up the entire SPY and guarantee  a 2% payout increasing with inflation with infinite duration at its current valuation and it should be AAA rated. One could argue that it this securitized bond were default, the US would probably default as well. It’s a Gedankenexperiment, but imo a helpful one.

 

Welcome to the dark side!  ;D

 

SD

[RuleNumberOne]

Some months ago, Warren Buffett said on CNBC that if there was a way to short the 30-year US Treasury and buy the S&P, he would do it.

 

It is a good thing there wasn't such a way, or the poor guy would be tearing his hair out right now.

 

Buffett missed out by keeping his stash in T-bills. All he had to do was to ride with the robots.

 

It is not too late to get on the 30-year train with the robots - the ride from 2% to 0% gets you a 70% capital gain. If Buffett doesn't have the nerve, he can get off at 0.25% and still make a capital gain of 50% on his stash. There is trillions to be made by coat-tailing the robots.

 

Euro-Hero Mario Draghi (aka the "hero who saved the Euro single-handedly") backs the robots all the way.

[RuleNumberOne]

Long-Bond investors have been having a great time.

 

‘Greater fool’ theory drives weird world of negative yields

https://www.ft.com/content/29dc8738-ae0f-11e9-b3e2-4fdf846f48f5

 

"As Lex pointed out this week, German government debt has returned 30 per cent in the past year.

 

There may be more gains to come, but we are into “greater fool” theory here. We hear the arguments that insurance companies and pension funds need to match asset returns to future liabilities, but this only makes sense if those liabilities are going to shrink, which would be a novelty. Otherwise, lending at a guaranteed loss only makes sense if another buyer can be found who is prepared to risk a bigger guaranteed loss."

 

[John Hjorth]

Here is a story about how to be taken into surreal territory - the good way :

 

Jeudan A/S - [JDAN.CPH] - 2019H1 Report - [p. 1].

 

Porteføljen af renteaftaler på ca. DKK 11 mia. er ad flere omgange omlagt til lavere renteniveau i 2019. Seneste omlægning i august medfører en vægtet rentesats på -0,03 % p.a. og en gennemsnitlig løbetid på ca. 10 år.

translates to :

The portfolio of interest rate swaps of approx. DKK 11bn has been rolled to lower interest rates several times in 2019. The most recent change in August resulted in a weighted interest rate of -0.03% p.a. and an average maturity of approx. ten years.

 

[ ; - ) ]

 

- - - o 0 o - - -

 

I bought it first time in January 2013, then added in 2014, 2015 & 2017. EBVAT/share just continues every year to go up, up, up. What I especially like about it is that I've never received bad news from the company. I just read the company announcements as they come [mostly about new acquisitions or disposals], look at the quarterly financials and the annual report to see if there's any dividend coming my way, most of the year ends the answer is "No", and then I think : "Fine, please just keep my money".

[DooDiligence]

Here is a story about how to be taken into surreal territory - the good way :

 

Jeudan A/S - [JDAN.CPH] - 2019H1 Report - [p. 1].

 

Porteføljen af renteaftaler på ca. DKK 11 mia. er ad flere omgange omlagt til lavere renteniveau i 2019. Seneste omlægning i august medfører en vægtet rentesats på -0,03 % p.a. og en gennemsnitlig løbetid på ca. 10 år.

translates to :

The portfolio of interest rate swaps of approx. DKK 11bn has been rolled to lower interest rates several times in 2019. The most recent change in August resulted in a weighted interest rate of -0.03% p.a. and an average maturity of approx. ten years.

 

[ ; - ) ]

 

- - - o 0 o - - -

 

I bought it first time in January 2013, then added in 2014, 2015 & 2017. EBVAT/share just continues every year to go up, up, up. What I especially like about it is that I've never received bad news from the company. I just read the company announcements as they come [mostly about new acquisitions or disposals], look at the quarterly financials and the annual report to see if there's any dividend coming my way, most of the year ends the answer is "No", and then I think : "Fine, please just keep my money".

 

Street food is the best.

[RuleNumberOne]

The ECB is distorting the US yield curve. Why don't they try some fiscal stimulus instead of budget surpluses?

 

https://www.wsj.com/articles/theres-no-place-like-u-s-in-hunt-for-yield-11567080003

 

"Several analysts and investors are describing the buying spree by foreign investors as a revival in American exceptionalism—and they say they expect it to continue.

 

“I call this the new abnormal,” said Yoram Lustig, head of multiasset solutions for Europe, the Middle East, Africa and Latin America at T. Rowe Price .

 

The diverging outlooks between the U.S. and the rest of the world have pushed Mr. Lustig of T. Rowe Price and other investors in foreign assets to buy more Treasurys for clients in recent months, while maintaining or adding to their positions in stocks. He said he favors the positive yields of Treasurys over Germany, Japan, Sweden and other countries that contribute to the $16 billion stockpile of negative-yielding bonds.

 

Mr. Lustig said he has been using the strong dollar to boost his returns from Treasurys.

 

“For the first time in my career, I started buying U.S. Treasurys without hedging the dollar,” he said. “Having unhedged U.S. Treasurys in portfolios gives you exposure to two safe-haven investments.”

Traditionally, he said he hedged Treasury purchases to account for currency fluctuations, with the cost usually being the difference in short-term rates between the two countries. But the dollar has defied most analysts’ expectations over the past 18 months. The WSJ Dollar Index, which measures the greenback against a basket of international currencies, is up 2% this year after notching a fresh high Wednesday."

[TwoCitiesCapital]

**Editing because I realized that it was a different thread that I had this conversation in. Including that section from that thread below**

 

 

Negative rates in Europe have inverted the US yield curve.

 

Dan Fuss:

https://www.barrons.com/articles/why-bond-legend-dan-fuss-is-buying-at-t-stock-51563363000

 

"The flows of capital from abroad means the gulf between ultralow or negative yields elsewhere and the high U.S. yields will have to narrow, he continues. "

 

Fed chief Powell said 2 days ago:

 

https://www.cnbc.com/2019/07/16/feds-powell-says-uncertainties-have-increased-chances-of-a-rate-cut.html

 

“We have seen how monetary policy in one country can influence economic and financial conditions in others through financial markets, trade, and confidence channels. Pursuing our domestic mandates in this new world requires that we understand the anticipated effects of these interconnections and incorporate them into our policy decisionmaking,” he said.

 

While I don't disagree with the statement overall, I'd like to see flows information confirm it.

 

It was my understanding that this was, in part, what drove the 10-year to 1.60% back in 2016, but since then I thought it had been a net negative return for most foreign buyers to buy treasuries and hedge the currency risk which has eliminated a lot of the foreign demand over the past 2 years.

 

Is there any flow data supporting foreign buyers?

If the references I looked at are correct, US government debt held by foreign entities has increased ++ after the last recession but has relatively plateaued.

https://fred.stlouisfed.org/series/FDHBFIN

However, the US government has issued debt at a rate much higher than GDP growth and somebody/somewhere has been piling up. In percentage terms, US government debt held by foreign entities over total US government debt (as per the Treasury Department) has risen from about 25% entering the Great Recession peaked at around 34% in 2013-6 and is now on its way down to 29% even if absolute numbers keep going up. Remember also that the Fed has recently been a net seller of government debt. Against all odds, rates have gone down despite the increased supply and demand from US individuals and institutions (including banks) seems to be the driving force.

Here is official data showing what happened recently (over a year-period when public debt increased by 960B).

https://ticdata.treasury.gov/Publish/mfh.txt

From a bird's eye view it seems that the fear and greed spectrum looks more and more like the bimodal distribution that is becoming obvious in other segments which cannot be discussed in investment threads. The US continues to have the cleanest dirty shirt but it's getting dirtier in our beg-thy-neighbor world.

 

I think this supports that we cannot believe that it's foreign buyers. Foreign held treasuries have increased slightly since 2016, but at a far lesser rate than the supply which results in them owning a significant % of the total supply less than their peak in 2016 (as you pointed out).

 

If foreign buyers went from 34% ownership of the Treasury market to 29%, they certainly can't be the cause of the recent drop in rates - someone else had to absorb their 5% reduction along with the increase in new supply.

 

I would tend to believe the BofA CEO because he has the whole of Merrill Lynch at his disposal to find out what's going on (does anyone here know why the Treasuries held by "private investors" has more than doubled from $6 trillion to $14 trillion in the graph from the same website linked below?). But whether or not it is foreign buyers, let us look at the duration risk.

 

https://fredblog.stlouisfed.org/2018/04/whos-buying-treasuries/?utm_source=series_page&utm_medium=related_content&utm_term=related_resources&utm_campaign=fredblog

 

home.treasury.gov/news/press-releases/sm679

 

Press release from May 2019. Pietrangeli is the Director of the Office of Debt Management and a member of the Treausry Borrowing Advisory Committee. I'd take what he says, and the data, over what BofA says any day.

 

Pietrangeli next reviewed recent tends in foreign holdings of Treasury securities. He noted that foreign participation in auctions remains in line with historical levels and the amount of foreign holdings had remained steady or had increased gradually since 2014, even as borrowing needs have grown substantially . He concluded that domestic buyers have increasingly absorbed the larger debt issuance since 2014.

 

Once again, it's not foreign buyers driving U.S. rates

 

 

The ECB is distorting the US yield curve. Why don't they try some fiscal stimulus instead of budget surpluses?

 

https://www.wsj.com/articles/theres-no-place-like-u-s-in-hunt-for-yield-11567080003

 

"Several analysts and investors are describing the buying spree by foreign investors as a revival in American exceptionalism—and they say they expect it to continue.

 

“I call this the new abnormal,” said Yoram Lustig, head of multiasset solutions for Europe, the Middle East, Africa and Latin America at T. Rowe Price .

 

The diverging outlooks between the U.S. and the rest of the world have pushed Mr. Lustig of T. Rowe Price and other investors in foreign assets to buy more Treasurys for clients in recent months, while maintaining or adding to their positions in stocks. He said he favors the positive yields of Treasurys over Germany, Japan, Sweden and other countries that contribute to the $16 billion stockpile of negative-yielding bonds.

 

Mr. Lustig said he has been using the strong dollar to boost his returns from Treasurys.

 

“For the first time in my career, I started buying U.S. Treasurys without hedging the dollar,” he said. “Having unhedged U.S. Treasurys in portfolios gives you exposure to two safe-haven investments.”

Traditionally, he said he hedged Treasury purchases to account for currency fluctuations, with the cost usually being the difference in short-term rates between the two countries. But the dollar has defied most analysts’ expectations over the past 18 months. The WSJ Dollar Index, which measures the greenback against a basket of international currencies, is up 2% this year after notching a fresh high Wednesday."

 

It's one perspective by one asset manager that was refuted by the head of open market operations at the Treasury as recently as May. I'll take the guy who sees the big picture of a guy who is a small contribution to that picture any day.

 

I also have some qualms with what he is saying here:

 

1) The USD is does not always behave as a safe haven in recession. It did in 2008, 1980, and 1982 but failed to in 2000, 1990, and 1974 (i.e. the dollar declined in value during the recessionary periods). Also, I'm sure it's a mixed bag in any given year as to which currencies the dollar outperformed/underperformed so a lot of this is also very dependent on which currency you're considering. Thus, to say it's a safe haven to that will hedge a global recession is less than conclusive and I think most managers know.

 

2) The volatility in the USD far exceed the yields on bonds if you're buying them on a un-hedged basis. The USD is up 2% this year. If that reverses, on an unhedged basis you've lost nearly the entire total return for the year for any tenure of bond closer than 10-years. The USD is up 5% from the lows in early 2018 - a reversal there would wipe out 3-5 years of coupon return depending on what tenure you're buying. No self-respecting fixed income manager is going to expose themselves to that kind of volatility and risk losing 5-years worth of returns by not hedging the currency. These are not equity investors that are accustomed to risk - these are investors who choose bonds specifically to manager their aversion to risk.

 

 

[Cigarbutt]

The ECB is distorting the US yield curve. Why don't they try some fiscal stimulus instead of budget surpluses?

 

https://www.wsj.com/articles/theres-no-place-like-u-s-in-hunt-for-yield-11567080003

 

"Several analysts and investors are describing the buying spree by foreign investors as a revival in American exceptionalism—and they say they expect it to continue.

 

“I call this the new abnormal,” said Yoram Lustig, head of multiasset solutions for Europe, the Middle East, Africa and Latin America at T. Rowe Price .

 

The diverging outlooks between the U.S. and the rest of the world have pushed Mr. Lustig of T. Rowe Price and other investors in foreign assets to buy more Treasurys for clients in recent months, while maintaining or adding to their positions in stocks. He said he favors the positive yields of Treasurys over Germany, Japan, Sweden and other countries that contribute to the $16 billion stockpile of negative-yielding bonds.

 

Mr. Lustig said he has been using the strong dollar to boost his returns from Treasurys.

 

“For the first time in my career, I started buying U.S. Treasurys without hedging the dollar,” he said. “Having unhedged U.S. Treasurys in portfolios gives you exposure to two safe-haven investments.”

Traditionally, he said he hedged Treasury purchases to account for currency fluctuations, with the cost usually being the difference in short-term rates between the two countries. But the dollar has defied most analysts’ expectations over the past 18 months. The WSJ Dollar Index, which measures the greenback against a basket of international currencies, is up 2% this year after notching a fresh high Wednesday."

Interesting.

In order to understand better the potential for unintended consequences, one can look at what Japanese banks have been doing as they may be, in some scenarios, some kind of leading indicators unless the decoupling issue persists.

 

The JGBs bond market has been essentially captured by the BOJ and some contend that they have put in place a structure that has neutralized bond vigilantes. Domestic investors cannot (and no longer) rely on the negative yield provided by JGBs and international variable interest seems to be guided by unhedged bets vs currency fluctuations (IMO).

 

So, in these circumstances, if you're a Japanese bank, what do you do? You reach for yield in a very crowded field! Japanese banks (and pension funds it seems) have been progressively moving up the risk curve and I recently read that, with 10-yr US gov. bond yields being where they are, Japanese banks now can expect to receive a net negative yield on US risk-free instruments once hedging costs are taken into account. Japanese banks have piled into global real estate-backed bonds (including Australia), packaged leveraged loans and even equity (domestic and global) and it seems that flying without a parachute (unhedged) may be the way to go forward, at least for some, in this new era. Another interesting feature is that central bank-related authorities have modified accounting rules to allow banks to avoid mark-to-market accounting vs the potential fluctuations of these 'higher-yielding' instruments and allow to report capital gains, when realized, as a separate line item, within the calculations for the net interest margin which has become negative (!) for many banks otherwise.

 

In terms of neutralizing vigilantes and disinhibiting animal spirits, Japan has been the champion of the three-arrow policy (monetary, fiscal and reform) but I wonder if historical parallels should not make possible a reconsideration of the present trajectory. In 1932, as part of a several-arrow strategy, the finance minister Takahashi got the BOJ involved in bond buying to mitigate Depression anesthesia of animal spirits. When unintended consequences kicked in, he tried to restore fiscal discipline but his attempts stopped unexpectedly. After WWII, a tight leash was put around the BOJ in order to prevent it from doing things that could eventually erode the foundations of capital markets.

 

There is potential for competitive currency devaluations going forward. Who's going to win?

https://www.bnnbloomberg.ca/years-of-living-dangerously-japan-s-low-yield-warning-to-world-1.1293571

 

 

[Spekulatius]

Sounds like negative interest rate is a surefire way to destroy the banking system. I guess we will find out if US Banks follow the zombie apocalypse if their Japanese and European peers.

 

The US banking system has less competition, so It won’t be quite as bad , but I could see a world of permanent sub 10% ROE and valuations below tangible book.