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Bill Blain: "This Is What Terrifies Draghi And Other Central Bankers"

Submitted by Bill Blain of Mint Parnters

Austria 2% for 100 year bond will go down as "financial moment". Wake up and smell the coffee of economic reality

Blain’s Morning Porridge – September 13th 2017

“Hey Satan, paid my dues, playing in a rocking band...”

This morning dawns bright and hopeful. After the Caribbean hurricanes, London survived a storm last night which ruffled the waters of the Thames, and caused some mild distress in terms of leaves blown off trees. Do your worst Mother Nature! England is ready!

Markets are enthused, boosted by talk of a US tax-reform roadshow, stock markets hitting new highs because the Norte Koreans haven’t found a match to light the fuse on their next firework, and Apple looking likely to get away with pushing the price of a new bright shinny thing past $1000.

I read a great line yesterday I suspect someone is going to ultimately regret: “We have solid global growth and some of the easiest financial conditions in history… hooray!”

It’s probably true we have ridiculously easy conditions – but playing it won’t be easy and I doubt there will be much to cheer as the unintended consequences of financial asset inflation play out! More about that below.

Or how about reading Goldman Sachs saying there won’t be a Global Stock Crash because “too many people expect it..” (Oh, yes they said it – months after I did!) It’s such an obvious triple bluff: Goldman might be saying they don’t expect the crash because they want you to think they do, but you will further out-think them and figure because they are Goldman and are so awfully smart they’ve worked out you would work that out… and they actually want to buy the whole market, or maybe it’s a quadruple bluff… I’m sure you get the gist.

The latest Merrill fund manager survey points out the highest level of investors hedging against a correction in 14 months. Meanwhile, my macro-man Martin Malone points out the market capitalisation of global equities now stands at 101% of Global GDP. At the time of the last correction in 2008 it hit 115%. The Average is around 80%. As we’ve said before. We reckon the smart money is still anticipating a correction – at which point it’s a buying opportunity.

Meanwhile, the story of the day was Austria launching its century bond. Euro 11bln plus of investors looking for a 2% return for a 100 year investment. I have a suspicion “2% for 100 years” may be the moment that defines the very last drink-addled, drug fuelled party days of the bond bull market – but, I’ve been saying that for years already!

However, bond maths always make sense. In bonds there is truth. Marcus Ashworth of Bloomberg sums it up:

“This new 100 year will be the most price-sensitive bond that exists. In any currency.

 

A one basis-point change in yield will move the price of this Austria 2117 issue by 43 cents, or 0.43 percent. That is because the coupon is so low for the ultra-long maturity, which makes the bond's duration -- or sensitivity to yield change -- so high.

 

If you wanted to make a bullish bet on European interest rates dropping again, then buying the new Austrian issue will give you the most bang for your euro. Portfolio managers look for such extra sensitivity to enhance the flexibility of their holdings.”

Of course.. if European interest rates go the other way.. perhaps because of normalisation panic - then you probably lose even more quickly as a retreat degenerates into a rout! (Mario Draghi – take note.)

Going back to my original quote about solid growth and easy financial conditions, it’s true: we do have unfeasibly low interest rates (LIRP, ZIRP and NIRP), low inflation, talk about co-ordinated central bank action, recovering economies, full employment in some, and all that good stuff. You can easily argue these are massive positive growth and value drivers.

For the last 10-yrs global central banks have been struggling to generate inflation to bail out the debt crisis. Now we have economies like the UK and UK pretty close to full employment (whatever that is?) and finally we’re getting some tepid inflation from Washington to Beijing. Macro economists are screaming in unconfined joy, almost wetting themselves with the realisation that 1% interest rates and 3% inflation is generating real interest rates of Negative 2%, full employment and making debt burdens sustainable.. Buy Buy Buy!

But, we are equally burdened by nearly 10-years of extraordinary monetary policy. $14 trillion of QE is only part of it – it’s the unintended consequences of that $14 trillion in driving over $200 trillion of financial asset price inflation that matters…

  • Bond yields are unreasonably low because of QE, driving false valuations across all asset classes. Fact.
  • Corporate, Hi-yield and Emerging Market spreads are unrewardingly tight due to the distorting influences of QE. Fact.
  • Stock markets are bid higher by yield tourists, and by the effects of corporates awash with cheap cash indulging in stock buybacks and investing their zero-cost borrowings in inflated financial assets. Fact
  • Even Non Financial Alternative assets are out of sync. Top end property prices no longer make any sense – yields from core London 2 bed flats (average price of £2.5mm) are less than 2%. Prime London (£1 mm ave small flat price) barely test 3%. (UK house priced up 5.6% last year – but not so much in London) Facts.
  • Alternatives like Wind Farms are now yielding a fraction of what they did just a few years ago – although at least that’s a product of bigger, better and more efficient and proper management..

In short… it looks like full employment, rising inflation and signs of growth are going to force normalization, at which point the bond music stops and we all realise financial assets have been dancing naked in the Emperor’s New Clothes lap-dancing bar as the proverbial tide goes out! 

As I said last week, that’s a prospect that must terrify Draghi and other central bankers. He needs this to keep going on long enough for real recovery to overtake the prospects of a correction.