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Tuesday 19 March 2024

Corporate bond fund managers Stefan Isaacs and Richard Woolnough have just come back from New York, where they spent a couple of days meeting economists and bond market strategists. While they were there, they took the opportunity to film a short video. In it, Stefan and Richard discuss the US bond market, central bank intervention, and the lack of consensus on the outlook for corporate bonds.

 

It was big news when Postfinance, the first Swiss bank categorised as “too-big-to-fail”, announced the introduction of negative interest rates to customers holding deposits of CHF 1 million and above. Many are now asking how long it will take until banks apply this approach to retail savers. I would argue that it may not be too long given the situation for Swiss banks remains challenging.

Part of the Swiss economy depends notably on Europe given important trade links. Because of this, the Swiss National Bank (SNB) is trying to work with the EUR/CHF exchange rate through a combination of negative interest rates and market intervention in the currency market. In the first two weeks after the US election, the SNB’s sight deposits, the most important means of financing for currency purchases and hence an indication of market intervention, have risen by more than CHF 6bn.  To put this in context, this is roughly half of the intervention seen in the week before the EUR/CHF peg broke in Jan 2015. The Swiss Franc, known as a safe-haven currency, was seen as a decent place for investors to hedge against Trump’s reflation policy.

It is unlikely that the SNB would raise interest rates before the European Central Bank (ECB) unwinds its quantitative easing programme, given the upward pressure it would put on the Swiss franc. The ECB is expected to keep negative interest rates unchanged and extend its QE programme for at least 6 months at the upcoming December meeting. As a result, the SNB’s monetary policy stance of deeply negative interest rates appears here to stay. I wrote earlier in the year about the delicate situation the Swiss banks find themselves in. The banking sector is suffering under the negative interest rate environment, and major Swiss banks have until recently been reluctant to pass on negative rates to private customers. This is based on fears of eroding some of their deposit base.

Swiss banks face the additional problem of a flat interest rate curve, which has squeezed the net interest margin from their maturity transformation business. As maturity transformers, banks are notable earners of term premia, and the flat yield curve has caused a further drag on bank profitability. As shown in the chart below, the Swiss yield curve is still relatively flat when compared to UK and US yield curves, even after the recent sell-off in long-dated government bonds. The US and UK government bond curves have thereby been particularly hard hit, given the market’s assumption that the respective governments of both nations are likely to increase debt issuance to finance fiscal spending.

negative-interest-rates-are-here-to-stay

While the Swiss interest rate curve may steepen further due to technical factors like developed market yield differentials, the fundamental economic environment should continue to exert downward pressure on yields. Even though economic growth has been surprisingly robust despite the headwind of an overvalued currency, Swiss real GDP remains below its long-term trend rate. The SNB’s GDP forecast for 2016 is estimated to be approximately 1.5%, and growth is not expected to accelerate by much from here in coming years. The economy is also some way from generating any sort of upward inflationary pressure, and has been in deflation for two years. While a positive headline inflation number is likely to be seen in the months ahead given the increase in oil prices, core inflation remains low which should limit the upside for inflation in the next few years.

Turning to regulatory developments, Swiss banks also face more stringent capital requirements for their risk-weighted assets and tighter leverage ratio rules than their peers around the globe, given the size of some banks that makes them systemically important for the Swiss economy.  The more stringent capital requirement rules put in place for Swiss banks have even been given a name in the financial regulatory scene – “Swiss finish”.

Given the above developments, Swiss banks are now forced to find new ways to ensure a profitable business model. We’ve seen already banks passing on negative rates via higher fees and higher borrowing rates, but now that Postfinance has broken the ice by charging deposits of private customers directly, I expect other major banks to follow. Negative interest rates are likely to be the new normal for Swiss bank account holders, at least over the medium term.

In this week’s edition:

  1. Gilt yields and Autumn statement
  2. 2-year Treasuries/Bunds: Yield differential at long-term high
  3. Risk premium for peripheral yields.

Tune in for the charts and articles that are making headlines in bond markets.

 

(Blog originally posted on www.bruegel.org)

Recent declarations by political leaders suggest that a hard Brexit is the most likely outcome of the negotiation between the European Union and the United Kingdom that will start next spring after the UK government triggers Article 50. In Britain, several cabinet members have made statements pointing in this direction. And in Brussels, Donald Tusk, president of the European Council, declared last week that “it is useless to speculate about ‘soft Brexit’…[T]he only real alternative to a ‘hard Brexit’ is ‘no Brexit’”.

But there is still a certain degree of fuzziness about what the different degrees of Brexit actually entail. Clearly, no Brexit implies that the UK would remain a member of the European Union, presumably on the terms that prevailed before the referendum. There is less clarity, however, on what a hard or soft Brexit would imply.

We attempt to fill this gap by setting out the options for the future EU-UK relationship (see table). In doing this, we have borrowed heavily from the work of three economists at HSBC[1] on the degree of Brexit, going from no Brexit to the hardest possible form of Brexit. We consider:

  • ‘Full EU membership’ (‘no Brexit’);
  • ‘EFTA EEA’: a soft Brexit option, which would be like the situation of the three European Free Trade Area (EFTA) members (Iceland, Liechtenstein and Norway) which belong to the European Economic Area (EEA);
  • ‘EFTA Switzerland’: also a soft Brexit option, which would be equivalent to the situation of Switzerland, an EFTA member which does not belong to the EEA;
  • Continental Partnership: an hybrid between soft and hard Brexit, proposed by Jean Pisani-Ferry, Norbert Röttgen, André Sapir, Paul Tucker and Guntram Wolff as a model for the relationship between EU and non-EU European countries (not only the UK, but also the EFTA members, Ukraine, Turkey and others);
  • ‘CU with Turkey’: a hard Brexit option, which would be like the EU-Turkey customs union (CU);
  • ‘FTA with Canada’: another hard Brexit option, which would be like the situation of Canada if the proposed EU-Canada Comprehensive Economic and Trade Agreement (CETA), a sophisticated free-trade area (FTA) agreement, goes ahead;
  • ‘WTO rules’, the hardest version of hard Brexit, which would give the UK access to the EU market (and the EU access to the UK market) on purely WTO terms, with no preferential arrangement.
beyond

For each of these seven options, the table shows whether the UK would participate in 10 different EU policies or processes – some identical to those examined by the HSBC economists and some that are different from theirs. The table asks, for each option, whether the UK would:

  • Have access to the EU single market;
  • Abide by the free mobility of labour;
  • Abide by related single market rules (competition, labour, environment, etc);
  • Have a say in EU rulemaking;
  • Be bound by European Court of Justice (ECJ) rulings on the single market;
  • Have duty-free access to the EU for goods;
  • Have access to the EU market for services;
  • Be part of the EU commercial policy;
  • Be part of the agricultural policy (and the fisheries policy);
  • Contribute to the EU budget.

For ease of reading of the table, the cells where the answer is Yes (implying that the UK would participate in the relevant EU policy or process) are coloured dark green and those where the answer is No (indicating that the UK would not participate in the relevant policy or process) are coloured red; the cells in light green or light red are areas in which the UK would participate partially in the pertinent policy or process.

Close scrutiny of the table and of the colours of its cells suggests the following:

  • ‘No Brexit’ and ‘WTO rules’ are indeed two extreme and opposite cases. The former would imply continued EU membership and therefore full participation in all 10 EU policies or processes. By contrast, an EU-UK relationship based on mere WTO rules would turn the UK into a ‘third country’ with respect to the EU, with zero participation in its policies or processes, the hardest form of Brexit.
  • Participating in a Turkey-like customs union or in a Canada-like free trade agreement with the EU would also qualify as hard Brexit. In both instances the UK would only participate in two of the 10 EU policies or processes considered here: duty-free access for goods plus the EU commercial policy (in the CU case) or (partial) market access for services (in the CETA-like case).
  • Participating in the EEA arrangement would be the softest possible form of Brexit because the UK would still participate in seven of the 10 policies or processes. The three excluded areas fall into two categories. First, some EU policies: the common commercial policy and the common agricultural policy (plus the fisheries policy). Second, single market rules: EEA countries are full participants in the single market, have to abide by all single market rules but have little or no say in the rulemaking process. This form of soft Brexit would certainly be welcomed by the EU27 but most likely rejected by the UK.
  • Participating in a Swiss-type arrangement would also qualify as a soft Brexit, though slightly less soft than the EEA arrangement. Under the Swiss arrangement, as under the EEA arrangement, the UK would not participate in the common commercial policy, in the common agricultural policy (or the fisheries policy) and would have no say in EU rulemaking. In addition, the UK would only partially be bound by ECJ rulings. The price it would pay for this, like Switzerland, is that it would only be a partial member of the single market: it would only have partial access to the EU market for services and in particular it would not enjoy passporting rights for financial services. Whether or not the EU27 would be willing to offer this option to the UK and whether the UK would be interested is a moot question at this stage. An important issue that will need to be resolved first is the fate of the free labour mobility clause between the EU and Switzerland. This clause was rejected by Swiss voters in 2014 and is considered as a ‘sine qua non’ condition by the EU. If no agreement between the two parties can be found soon, this option may simply not be available any more by the time Article 50 is triggered.
  • Finally, the Continental Partnership option is ‘sui generis’: it belongs neither to the hard nor soft Brexit categories. Instead, the Continental Partnership:
    • Shares some important features with soft Brexit: the UK would have full access to the single market for goods, services and capital in exchange for respecting all single market rules, abiding by pertinent ECJ rulings and contributing to the EU budget;
    • Shares an important feature with hard Brexit: the UK would not maintain free labour mobility with the EU, but contrary to hard Brexit which would have no mobility at all, the Continental Partnership would have controlled mobility;
    • Shares two features with both hard and soft Brexit: the UK would have duty-free access to the EU goods market, but it would not participate in the EU agricultural and fisheries policies;[2]
    • Is different from both hard and soft Brexit in one important respect: the UK would have a voice – though not a vote – in the EU’s single-market rulemaking process.

In conclusion, assuming that despite the current mood – which was well encapsulated by President Tusk’s recent speech – there will eventually be some appetite for an arrangement with the UK that is neither hard Brexit nor no Brexit, the Continental Partnership option is likely to prove more attractive than soft Brexit because it combines elements of both soft and hard Brexit while adding an element that exists in neither category. The Continental Partnership option offers another advantage over alternative options under which the UK would maintain a close tie with the EU. Because they are premised on free circulation of workers in order to grant free circulation of goods, services and capital, neither no Brexit (ie EU membership) nor soft Brexit (ie the EEA and Swiss models for non-EU countries) seem realistic templates for dealing with countries like Turkey. By contrast, the Continental Partnership model without free labour mobility could be applied not only to the UK post-Brexit but also to Turkey and to other EU neighbours.

[1] Simon Wells, Liz Martins and Douglas Lippoldt, ‘Brexit getting harder: reassessing the prospects for a complex divorce’, HSBC Global Research, 6 October 2016.

[2] It may, however, participate in the EU commercial policy.

In this week’s edition:

  1. Trump part 2! Latest market reaction
  2. What’s behind the rally in US Libor?
  3. Italian referendum update

Tune in for the charts and articles that are making headlines in bond markets.

 

Last weekend we were at the brilliant Kilkenomics festival in Kilkenny, Ireland.  Whilst we were there (and it’s a fantastic town) we filmed this short video.  In the wake of the Trump election victory there’s a mini-panic going on in Ireland, not least because, in common with Mexico, there are many undocumented Irish in the US whose future has become uncertain.  There’s also the huge issue of Foreign Direct Investment (FDI) and so-called “tax inversion”.  The influx of US companies to Ireland to take advantage of its 12.5% corporate tax rate has (artificially?) massively boosted GDP, and therefore also reduced its debt/GDP ratio dramatically.  Do these companies head back to the States on the back of a Trump tax cutting agenda?  In our film we also discuss the housing market, and the impact of Brexit.

 

The bond market was intimidating during the Clinton years, and has started as it means to go on for Trump’s term.  As we celebrate this website’s 10th anniversary, it proves fitting that the bond market reminds us why we named the blog as we did.

“I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”-  James Carville, Clinton administration advisor, 1993

The result of the US election was a surprise given the polls, but the exceptionally short-lived “risk-off” reaction in bond markets has been just as unexpected. When the UK experienced its own political shock in June, there was a textbook flight to quality government bonds globally, with the US 10yr bond price rallying 2% the day after and peaking two weeks later. As a UK centred event, the moves in UK government bonds were even more pronounced; 10yr gilt yields rallied over the next six weeks to historical lows of 0.5% in August, helped of course by the QE announcement.

bond-market-sell-off1

The US has just arguably delivered the biggest shock in modern political history, yet the flight-to-quality effect lasted just hours. Since then, the government bond market sell-off has been marked across the curve. In just two days the US 10yr saw a 30bp yield sell off, closing the US session at 2.15% up from the polling day close of 1.85%. In the longer end of the curve, US 30yr yields climbed 33bp.  US breakevens now reflect increased inflation expectations, with inflation-protected TIPS outperforming strongly.

Whilst Trump promised much in the run up to the 2016 US election, the detail has been sparse and it is still too soon to know what his administration will focus its efforts on. Having won Congress as well as the presidency, Trump and the GOP have the ability to enact the promised pro-growth policies such as fiscal stimulus via tax reform, and infrastructure and defence spending.  Though there remains some uncertainty about the willingness of Tea Party Republicans to back the higher spending part of these promises, one thing is certain: the bond market has already moved aggressively.

bond-market-sell-off2

The term bond vigilante alludes to the ability of the bond market to serve as a restraint on the government’s ability to over spend or borrow. As a protest to monetary or fiscal policy, market investors may sell bonds, causing yields to rise. Although the name implies something rather more sinister and deliberate, it’s simply a term to describe the uncoordinated actions of a large number of rational economic agents.  It was coined by Edward Yardeni in response to the Reagan era where expansionary fiscal policy in the early 1980s drove bond market investors to demand a much greater return from government bonds. When Reagan took office, he inherited a sluggish economy and inflation near a staggering 15%. He proposed the Economic Tax and Recovery Act; a bill to cut taxes while reducing government welfare spending. Yields climbed to all-time highs. The 5yr yield rose to 16.3%; higher than both the 15.8% yield demanded on the 10yr and 15.2% yield for 30 year lending – near term default risk was being priced as a legitimate concern, even though debt to GDP was just 30% vs 90% now – Reagan had much more fiscal headroom than Trump does today.  It’s time to re-read our Reinhart and Rogoff.

bond-market-sell-off3

One week of falling Treasury prices does not a bear market make.  But if Donald Trump intends to flex the fiscal lever, bond market vigilantes could return with a vengeance, making it increasingly expensive for him to do so.  And we didn’t  even get round to discussing the next POTUS’s famous pre-election quote about voluntarily defaulting on Treasuries…

This week on Bond Vigilantes TV:

  1. Trump! Treasury sell off and Reaganomics
  2. Bad news for Ireland
  3. EM debt sells off even as commodities rally

Tune in for the charts and articles that are making headlines in bond markets.

 

Today is the 10th anniversary of the Bond Vigilantes blog.  Here’s a look back at the incredible changes to bond markets and monetary policy that we’ve been through over that decade.  Also today we are launching our new book (the difficult second album) in support of Cancer Research UK.  There’s a link to our Just Giving page at the bottom if you like what we do and can spare a few quid.

My first ever piece on the blog, back in November 2006, reported that the Bank of England had just raised interest rates to 5%, and suggested that with inflation at 3.6% (the highest for 8 years) and house prices rising, nobody should have been surprised. We know what happened next though.

With the US Federal Reserve having also raised rates to 5.25%, earlier in the year, the American housing market began to cool rapidly, and after annual price gains of between 5% and 12% since the turn of the millennium and significant speculative overbuilding, boom turned to bust. Consumers sank underwater on housing loans, and delinquencies and defaults ballooned. Mortgages had always been regarded as “safe” loans, and financial institutions had not only taken on huge leverage themselves to finance them, but had also originated and repackaged these debts to sell to financial institutions globally. In what was then considered a low yielding world, Asset Backed Securities (ABS) and new financially engineered instruments such as Collateralised Debt Obligations (CDOs) offering potentially higher returns for theoretically low credit risk, became widely held. This meant that when the housing crash came, and US house prices fell by an average of 5% per year from 2007 to 2011, the distress was widespread and not confined to American banks.

Closures of ABS funds were followed by skyrocketing funding costs for banks in desperate need of liquidity, and collapsing bank equity prices. Eventually Lehman Brothers defaulted, and US financial institutions were bailed out by taxpayers and the Federal Reserve. Queues formed outside distressed banks in the UK, and Northern Rock and the Royal Bank of Scotland were nationalised as policymakers realised that what was happening had echoes of America’s Great Depression. Bailouts and nationalisation were not the only emergency responses though. Monetary policy changed forever in response to the supply side shock of weak banks (lack of lending), poor consumer demand (over-leveraged and experiencing negative equity on housing loans), lack of business investment (low confidence in future growth) and deflation fears. Interest rates were slashed by central banks (0% – 0.25% by the end of 2008 in the US), and extraordinary policies such as subsidised lending to the banking sector were implemented. Most importantly, we also saw central banks print money to buy back government bonds from investors – Quantitative Easing (QE).

QE was designed to generate both growth and inflation. By lowering borrowing costs in capital markets, businesses would become more profitable and might invest more. Households would see interest costs reduced. And the so-called “portfolio rebalancing” effect would encourage investors such as ourselves to sell our expensive and low yielding government bonds to take riskier, higher yielding positions which would help finance the real economy. Did it work? Well the academic literature – much written by the central bankers themselves – says yes. Inflation and growth were both higher than they would have been without QE. But as a politician once said, “you can’t put a counterfactual on a bumper sticker”. We will never know how bad things would have got if QE hadn’t happened, or indeed whether more “creative destruction” – letting failed institutions go bust, rather than limp on as bailed-out zombies – might have been a better outcome. Anyway, no feel good factor returned, and what started off as a financial sector crisis had, by the time the Bond Vigilantes blog reached its 5th anniversary, become a sovereign debt crisis in Europe. Weak growth, poor demographics, badly capitalised banks, government indebtedness and imbalances within the Eurozone proved a toxic mix. Spanish, Italian, Irish and Portuguese government bond yields spiked. Greece had to be bailed out by creditors including the International Monetary Fund (IMF).

Government indebtedness became an economic football. On the one hand books like “This Time is Different” by Reinhart and Rogoff warned of dire consequences for nations that allowed government borrowing to hit 90% of GDP. This helped inspire a cult of austerity (for example in the UK under Chancellor George Osborne) where fiscal tightening was thought to be needed, despite the huge shock to growth that had been experienced. Others, like Olivier Blanchard of the IMF, warned that the negative multiplier effects from austerity would cause the downturn to persist, and that Keynesian stimulus was desirable. On the whole the austerians won, and monetary policy rather than fiscal policy was left to do the heavy lifting. Which brings us to the start of our new book, covering the next five years of the ongoing Great Financial Crisis.

First the good news. Unemployment has fallen dramatically from the levels we saw in 2009. From 10% in the US, we now have just 4.9% of the American workforce out of work. We have a similar level of joblessness in the UK, and even in the Eurozone the unemployment rate is falling. Another reason to be cheerful is the relative stability in the financial sector. Having been forced to raise capital, been subjected to periodic regulatory “stress tests”, and having access to cheap central bank money, banks are less of a threat to the economic system. But things still just don’t feel “right”, even though in December 2015 the Federal Reserve felt able to finally hike rates by 25 bps.

For although unemployment rates have fallen, workers have not seen the wage rises that we might have expected. Partly this could be due to lower participation rates in the US (people leaving the workforce because they are discouraged by fruitless job-seeking, flattering the unemployment numbers), but there are also good arguments to say that we now exist in a global labour market and that capital will move jobs to lower cost regions (for example emerging markets) rather than pay higher wages. “The Rise of the Robots” by Martin Ford makes the scary prediction that we are entering a period of rapid robotisation and use of artificial intelligence that will steal jobs and wages from not just manual workers, as has always been the case, but high skilled middle class jobs too. Unemployment will rise as a result, and because robots don’t buy stuff, our consumer based economies will enter a negative spiral. The feeling that the average citizen has not seen incomes rise by much in real terms for many years now is likely to be a factor in both the lack of economic animal spirits and the rise of anti-establishment politics.

The Greek economic crisis (its unemployment rate hit nearly 30%) led to the rise of both far right (Golden Dawn) and far left (Syriza) political parties. Populist parties also emerged in Spain (for example Podemos who have suggested government debt forgiveness), and you could argue that the success of UKIP and Jeremy Corbyn, and the Front National in the UK and France respectively, as well as Trump and Sanders’s popularity in the US, can be linked to the perception that incomes have stagnated for most workers whilst the “1%” have become richer as the result of QE and other post-crisis policies. The UK’s two referendums, the first on Scottish independence, the second on EU membership, also look like self-inflicted wounds from a purely economic standpoint, but may reflect voter dissatisfaction with remote “elites”. Whilst most studies show that immigration may have only a marginal impact on wages (depressing them), globalisation is certainly no longer regarded as only a good thing.

When China joined the World Trade Organisation in 2001, it felt like the movement towards global free trade was a one way street. No longer. Might we see the return of tariffs and trade barriers? And as monetary policy runs out of power, many nations have attempted to weaken their currencies in the hope that a competitive devaluation might stimulate their export trade in a way that lower rates couldn’t. Currency wars are of course a zero sum game.

Five years ago, China was still a bright spot in an otherwise gloomy picture for global growth. Having bounced back from the Great Financial Crisis with some well-timed fiscal stimulus, its official GDP number was growing at around 10% per year. As an example of an investment led economic miracle, China was a poster child. No other nation had invested a larger share of GDP for as big a boost to economic output as China had, and on a Purchasing Power Parity measure, it became the world’s biggest economy in 2014. But not all investment is good investment, and the “bang for the buck” China was getting for each additional project started, has fallen dramatically in recent years. I remember attending an IMF meeting in Tokyo in 2012 where I heard Professor Michael Pettis speak. He told the audience that Chinese growth would average below 5% for many years as a result of over investment and bad loans, especially to the State Owned Enterprises (SOEs). I saw almost all the audience snigger and make “he’s gone mad” faces to each other, and I realised that a China slowdown was not on anyone’s investment radar. And with China being the biggest export market for many other emerging markets, and commodity producers such as Australia, when the continual slowdown began at the end of 2012, there was pain for countries like South Africa, as well as for metals and mining companies.

Simultaneously, oil prices were hit from the supply side. The opening up of shale oil fields in the lower American states led to oil prices halving, and then halving again, between 2014 and the end of 2015, provoking a new deflation scare as headline inflation rates (where direct energy contributions are around 10% to 15% of the basket) turned negative.

And if inflation rates turn negative and central bank rates are already at zero, what can you do? Switzerland had briefly instated negative interest rates in the 1970s to deter foreign currency speculators, but aside from this the world entered new monetary policy territory in the past couple of years. Switzerland, Denmark, Japan, Sweden and the Eurozone now all have negative rates. Will they work to stimulate growth and inflation? There’s little evidence so far to suggest it. Theoretically the impact of negative and positive rates should be symmetrical, but in a world where we can take our cash out of banks as notes, we can avoid paying a financial institution for the privilege of looking after our money. Safe deposit box sales have soared. Worse still for the central bankers, in a world where the banks realise that they can’t pass on negative rates to depositors for fears that they’ll withdraw all their money, they have to maintain their profits by increasing their lending rates. Swiss mortgage rates went up when the SNB cut rates. This is an unintended consequence that only the abolition of cash and a move to pure electronic money could prevent – the latter action would be intensely unpopular with populations. You should see the hate mail I got from the American Tea Party when I discussed the abolition of physical money in a newspaper article. It was almost as bad as that I received when I suggested that Scotland might not merit a AAA credit rating if it became independent.

Given the adverse impact on the banking sector in particular, I suspect that global rates won’t go much more negative than they already are. If that’s the case, is it time to suggest that we are also near the end of the bull market in government bonds that’s run since the start of the 1980s, when Paul Volker took over control of the Federal Reserve and set out to kill the inflation that had eroded returns for bond investors for two decades? We are now at record low government bond yields in virtually all developed markets, and there is over $11 trillion worth of negative yielding bonds outstanding worldwide.

If negative rates are not effective then, what do we do next if we have a new slowdown? Governments still seem reluctant to ease fiscal policy, and central bankers are running out of assets to buy as part of QE programmes. Having been seen as a crackpot idea even a few years ago, the idea that the authorities might use “Helicopter Money” to stimulate an economy is slowly edging into the mainstream of economic thinking. Rather than printing money to buy financial assets and hope that institutions use the cash they receive to make new loans and investments, central banks could print money to short circuit that transmission mechanism and give the money directly to individuals to spend (akin to dropping banknotes out of a helicopter) or they could directly finance infrastructure spending and other activities with high economic multiplier effects. Having been the first to suggest it might happen in a 2012 blog, I also wouldn’t rule out some form of government debt cancellation involving the bonds held on central banks’ balance sheets as part of QE. A cancellation of student debt owed to governments might however be far more powerful economically. The M&G bond team has covered all of the topics above on the Bond Vigilantes blog in recent years, and we’ve very much enjoyed doing it. We’re obviously fund managers and investment specialists rather than journalists, and the “day job” comes first, but setting out our views and creating charts really does help us to challenge or crystallise our own thinking.

Thanks very much for continuing to support us by reading our articles, for following us on Twitter, watching our YouTube videos and coming to our events. It’s much appreciated. As before all proceeds of the sale of this book will go to Cancer Research UK. Our last book raised over £10,000, so thanks also for your generous support.

If you’d like to, you can donate at our Just Giving page www.justgiving.com/fundraising/bond-vigilantes-anniversary-book. Also, we need to thank M&G for supporting the blog over the last decade, and all of the economists, strategists and experts who have helped us formulate our views.

It’s hard to imagine that the next five years can be as eventful as the past ten, but the whole global economic and political system just seems a little…odd, doesn’t it? So I’m not ruling it out. We go into our second decade with a new American president who appears to be about to initiate a Reaganomics-style stimulus.  It was the Reagan era deficits and resulting Treasury market revulsion that led to Ed Yardeni coining the term “bond vigilantes”.  When I named this blog the term was a mildly amusing historical relic.  It feels like that’s about to change.

The votes are in and it is clear. For the second time in 2016 we have had a major rejection of the political status quo. Following on from the shock UK referendum result, a Trump victory is further evidence that many believe that we have reached peak globalisation and income inequality. The perceived losers of globalisation have turned the incumbent political system on its head, and with it we should expect change.

So here are five predictions:

  1. The US will move to a fiscally accommodative stance. Whilst President-elect Trump may be somewhat constrained by a Republican controlled House of Representatives, it’s safe to assume we will see tax cuts, infrastructure and defence spending. With an economy at close to full employment this will prove inflationary in the medium term and yield curves will continue to exhibit a steepening bias. This should be positive for higher beta assets including the US high yield market.
  1. Inflation assets will outperform deflation assets. Paper assets will underperform the likes of commodities and property in a world where politicians are playing the populist card.
  1. Europe will face significant political challenges over the next twelve months. If we have learnt anything this year it is to expect the unexpected. Could we see significant political changes in France and Germany? Will Italy vote against Senate reform in the upcoming referendum on December 4? This could raise very real questions about the future direction of the Eurozone, an outcome which is certainly not priced into peripheral European markets at present.
  1. A Trump presidency will result in lower trade with Europe. As a result, the fragile recovery taking place in Europe could be put at risk. It’s too early to talk of ECB taper. They will extend their QE later this year after making some adjustments.
  1. Trump may not build a wall. But even if he does, it won’t keep the robots out. Their numbers are set to have more than doubled to over 2.5 million by 2020. Alongside a declining but nonetheless significant savings glut in Asia, the robots are the constraining factor on inflation and bond yields. Whilst bond yields will trend higher they will not return to pre-crisis levels.

Month: November 2016

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