Submitted by Bill Blain of Mint Partners
What Bond Market Crisis? What are the consequences across Credit and other Asset Classes
“But what a fool believes no wise man has the power to reason away.….”
It’s going to be a short comment this morning due to doing some media-commentary stuff earlier. Yesterday wasn’t quite the end-of-the world Bond Market Meltdown the headlines predicted. US 10-yr rates breaching 2.5% did not cause the entire bond market to vanish in a puff of logic as the realisation yields are set to rise set in. In fact, y’day’s US Treasury auction went rather well. The hollow threat of China selling its Treasuries was replaced by the sober realisation there isn’t really much else they can invest in – even the Chinese later said it was “fake news”.
As bond market gurus like Gross and Grundlach weighed in with negativity, I was expecting to be writing a note about market’s over-reacting to bad news – thus throwing up opportunities. Instead it’s possible markets have under-reacted. This morning comments abound with chatter about how nothing has really changed; the search for yield and value continues, and we’ve had folk bottom-fishing and looking for cheap offers. No one was apparently tempted or panicked into being a forced seller yesterday.
However, the market mood is definitely changed. We know there is a very serious debate being held across fixed income departments in the investment community: just how much and how quickly will the dramatic spread compression of the last few years be undone by the end of the bond bull market?
What are the consequences for investment books, how to hedge it, and how to play it. Hedge funds and credit are all playing curve games and looking for the next trade. I suggest they keep a very close eye on Linkers and other inflation plays as well.
Much money has been made investing across the tightening credit spectrum these past few years. It feels that party has come to an end. The mood was summed up by a conversation I had with one investor y’day as I tried to sell him a large block of peripheral European covered bonds: “Bill, even by your standards this is cheeky: you want me to buy a big block of bonds someone else wants to sell so they can realise massive profits… and you want me to do this on the very day the bond market turns decisively bearish?”
His comment is to the point: who will be the last fool buying spread product?
We’re trying to figure exactly how the end of QE distortions and rising/normalised bond yields play out across the credit spectrum. Highest risk will, of course, be US credit starting with high yield. Least volatile will be the SSA credits closest in quality to the proverbial risk-free rate. One big question is Europe where QE (to the tune of €30 bln a month) continues. We doubt European credit will remain entirely immune from the effect of wider US spreads.
More widely, CIOs are trying to figure the consequences of a bond bear market across all asset classes. What are the spillovers into stocks? One factor driving tighter stocks has been stock buybacks and M&A funded and fuelled by ultra-low interest rates. These are no longer going to be such significant drivers. And how about property – where higher rates will impact still cash-strapped under-payed and heavily indebted middle classes? Or in the UK where distortions include the home-builders making off like bandits with the Government’s Help-To-Buy electoral bribes?
So much to think about. How long before we get a headline saying Goldman Sachs are predicting $ 200 oil? (It happened..) Meanwhile, I think the Norwegians might be on to something as I read their SWF fund is looking to further broaden its remit to include Private Equity and, soon, infrastructure. That’s probably the way to go as the Great Financial Crisis 2017-2023 moves into its next phase: correcting the imbalances caused by 10-years of Financial Asset Inflation and Distortion!