Tuesday, 25 September 2018

On Bund yields, bond returns and German sausage

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Anthony Peters has a reminder of what bonds are for….

Back from my short one day excursion to Cologne – lunch in the sunshine overlooking the Rhine – and reminded of what if must feel like to be a money manager in an uncertain world with next to no room to manoeuvre and facing the near absolute certainty of a negative total return year.

As was said: “All we need now is for credit spreads to blow out, and then….”

I’d like to thank all of those who have over the past couple of days come back to me to comment on my musings of Monday morning where I observed that we might in fact have finally come to the end of a bond market cycle which began in 1973/74 and which has kept most of us in a style to which we have been quite happy to have become accustomed.

There is no reason to imply that we might be on the way back to 15% coupons on long bonds but even if the 10-year Bund were to return to 3%, it would cost us the best part of 20 points on a mark to market. That said, and this is something all of us must remember, bonds are as much about return of capital as they are about return on capital. Whether a bond trades up to 150.00 or down to 50.00 during its lifetime is utterly irrelevant, so long as at maturity it pays back at par which is what the object of the exercise is.

Equity geeks have been watching the volatility in our various markets and have been sniping that they thought bonds were supposed to be safe investments. Yes, they are! They get issued at par and they redeem at par. That’s where the safety and security is. The rest, the bit which pays our bills, is just a game of arbitraging fixed coupons against a shifting interest rate environment and a floppy yield curve.

In expressing the view that we will, with a high level of probability, not see new low yields in our respective lifetimes, I appear to have struck a chord although I strongly refute the suggestion that I might in any way be responsible for having caused the sell-off. I do, however, still question the role of the ECB in the hubris which pushed Bund yields down to 0.06% – they closed last night at 0.75% which represents a fall of just under seven points from the April 17th high.

Time for that old chestnut: Bund yields have risen tenfold in less than four weeks.

It does feel as though my German friends will not get their wish that they should at least be spared the pain of credit spreads blowing out too as the iTraxx S23 Xover closed last night at 290 points, quite a chunk wider from its own tight on April 10 of 242½ points. The iTraxx S23 Main has also had a stinker by widening over the same period from 52.90 points on April 10 to close at 62.40 last night which represents a shift of around 18%.

It might feel as though the year is already well underway but there are still seven and a half months until year end when the books take the mark to market so these guys will be sitting on painful and debilitating losses with the concomitant constraints to their freedom to act for a long old time. At least the sun was shining, the beer was fresh and the schnitzel tasted fine.

Inevitably, the subject of that unmentionable little country in the south-east of the EU came up. Despite the views of the powers that be in Berlin, the opinions expressed were quite clear; they have to go and until they’re gone investors will continue to sit in purgatory.

There appeared to be some confusion as to what it was that motivated “Angie” to fight so hard to keep the Greeks in. If there were to be broad consensus amongst Germans that the single currency project would be compromised if Greece were to be dismissed, that consensus did not stretch to our lunch table.

(As an aside, on the my return trip I purchased at the airport some liver sausage which I was hoping to bring for my 93 year old father as he enjoys on his breakfast toast. According to German security, though, liverwurst is a liquid and cannot be carried on board a plane. So my old man gave his life from the ages of 17 to 24 in defence of democracy, only to be subsequently deprived of his breakfast of choice. He must, on the 70th anniversary of VE Day, be wondering what the hell he did it all for.)

Meanwhile, the euro continues to recover – or could it be that the Greenback has lost its sparkle? Instead of hitting parity, the euro is now trading back up at US$1.1400 and I would not be at all surprised to see it at US$1.15 before the week’s trading draws to a close. Euro strength or dollar weakness? Probably a bit of both as the curves begin to close in on each other. The ECB is showing no signs of wanting to try to push on a piece of string and is letting markets get on with finding their own levels.

That this is not at all what St Mario appeared to have had in mind is a different matter entirely and one about which the boys in Frankfurt are remaining unusually stumm. Discretion, is in this case, quite clearly the better part of valour. How the Fed and the ECB should be reacting if the PBOC decides to ease again – perhaps that should be when and not if – is surely already taxing their respective minds but what is sure is that they can’t now make policy any more without a very keen eye on what is happening on the Chinese mainland.

Hardly productive

Back in the UK, we had the Bank of England’s Quarterly Inflation Report. Governor Mark “The Magician” Carney gave his customary press briefing while taking aim at the lack of productivity. That’s a hard thing to do in a service based economy; how do you make a taxi driver take more fares in the same period of time or, as they wondered on the wireless this morning, how does a hairdresser do more heads? I shall say nothing and simply repeat my maxim from above that discretion is… you surely know what I mean.


Alas, it is, for me at least, that time of the week again. I will be out tomorrow and Monday so all that remains is for me to wish you and yours a happy and peaceful week-end. May your youngsters give you the space to rest up after an second successive bruiser of a week and may they please not suddenly decide that they’re in love with Juve, conquerors of the mighty Real and expect you to suddenly come up with a replica strip for that one too.

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