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Monday, 11 December 2017

On the Fed cat and the bond pigeons

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Whoever might have been trying to make a bullish case for bonds this year must have already felt like the canoeist trying to paddle upstream through the rapids.

Anthony Peters, SwissInvest Strategist

As of yesterday, they would have added that sinking feeling that they are also trying to escape the pull of a waterfall right behind them as the minutes of the December FOMC meeting were aired and it emerged that the members had broached the most undiscussed subject in financial markets: when and how does one unwind quantitative easing.

This opening half week of the year has been dreadfully slow in terms of volumes but it has afforded those amongst us who did return plenty of time to talk to others in the market and to gauge what the key themes might be for the coming weeks. One insurance client of mine asked me for my call for the year-end gilt yield. On the basis that the economic recovery, what economic recovery there might be, is not expected to happen in a rising rate environment and with the central banks now armed with the necessary weapons to control pretty much the entire yield curve I plumped for 2.25%-2.30%.

Natural levels of demand and supply don’t really come into it, do they? Perish the thought!

As a follow up, I called on one of my more notable senior gilt market friends and asked him for his opinion on the subject; all I was looking for was confirmation that my shot in the dark hadn’t been aimed entirely in the wrong direction. There ensued the customary multi-asset conversation during which my chum niftily pointed out that with gilts yielding 2%, the equity markets had returned more in the opening day of the year than gilts promised to in an entire year. Since then, things have become even worse as the ten year benchmark gilt, the 2T 9/22, has dropped over 2 points in the first two days of trading and is therefore in negative total return territory before most of the lights have even been switched on in the City.

So the members of the FOMC have been discussing the whats, the hows and the whens of winding down the asset purchasing programmes. Year-end marks for 10yr Treasuries were at or around 1.75% and they too have backed up quite sharply, closing last night at 1.93%. The bear steepening of the yield curve is seemingly underway. This all goes to remind us that at a point in time when banks are being crawled over by regulators who are howling and screaming about openness and transparency, the market levels for debt and in consequence for equities too are being manipulated more or less at will by the monetary authorities.

Natural levels of demand and supply don’t really come into it, do they? Perish the thought!

The courage to switch it off?

Anyway, the FOMC comments certainly put the cat amongst the bond pigeons and turned a generally unattractive situation ugly. Yes, sooner or later the free money and unending liquidity policy will have to be reversed but although the patient is breathing easily on the life support system, does anyone have the courage to switch it off in order to find out whether he can go it alone?

In reality, all the Fed is suggesting that the time might have come to stop buying bonds. There was no mention of selling anything. And yet, the markets initially behaved as though the end of the world were nigh although they did catch themselves and it was appreciated that there is a long way from discussing something for the first time to implementing it. Nevertheless, the global bond market now clearly has a big bull’s eye on its back. As counterintuitive as it may appear, buying mainstream government bonds has become a fundamental “risk-on” trade.

Credit, on the other hand, had a special day in Europe as Spanish bank BBVA opened the financials market with a plain vanilla five year senior unsecured transaction and the slightly rag-tag syndicate of Commerz, Goldman, SocGen and HSBC nearly got trampled to death in the stampede. Priced at 336.4 bps over the Obl, it traded in the grey market as tight as -12 bps and it held on to that price level once the syndicate had broken and through the night. Just a couple of months ago, you couldn’t have paid people to take away Spanish bank risk, BBVA and Santander included, but there is a huge underweight out there and now that the market perceives that the worst of the Spanish crisis is over, the underperformance risk by not owning it is too great and they’ll be inhaling it, ’ere long.

Of course the risks aren’t over; it’s simply that the Yanks with their sundry cliffs have stolen the headlines and will most likely continue to do so until the debt ceiling cliff has either been scaled or fallen off along with the politically sensitive Superstorm Sandy reconstruction aid cliff and the defence budget cuts cliff. Has any smart university created a course yet called “Macroeconomics with Geology” or “Fiscal Accounting with Topography”?

Anyhow, I heard today that Spain apparently finds itself with a system which now sports one benefit drawing pensioner for every two working tax-payers. Shoring up the banks does not make that structural problem go away. But that could be a subject for another day.

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Alas, it’s that time of the week again. All that remains is for me to wish you and yours a happy and peaceful week-end. May you look at the empty fridge and empty bank account and console yourself that you’re not alone on your carrot juice and green tea diet. 

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