Blain's Morning Porridge - Jan 10th 2018. US Bonds hit 2.56% - this is moment we've been wai

Blain’s Morning Porridge – January 10th 2018

“Wisdom is one of the few things that looks bigger the further away it is..….”

The Morning Porridge is unrestricted market commentary freely available to all qualified investors on an unsolicited basis. It is not investment research.

US 10 year Treasury hits 2.56%. In Bond Markets lies the truth. Leaving aside the false-start blips early last year and in 13/14, the current rise in rates looks the clearest chart signal rates are normalising since before the crisis. Is the Bear Break above 2.50% in US rates the signal we’ve been waiting for?

Big names on the tapes are sagely confirming it’s the beginning of the bond bear market! The End of Days! Predictions say the 10-year bond will hit anywhere between 3-3.5% in the next 12 months. Some folk say the Japanese are to blame, while others are panicking about a bond debacle leading to a slew of defaults as sovereigns struggle to launch their front-loaded 2018 funding plans. (Some $65 bln of new government funding due this week!). Others are looking for the hi-yield bond markets to melt-down. There are some saying buy Financials as higher rates are great for their margins, while doomsters say dump tech stocks.

What does it all really mean?

Ladies and Gentlemen – welcome to the new world..

We are back in a bond environment where the realities of economic activity come back to the fore: inflation, the economy, job’s and wage growth, economic activity, demand and supply blockages and bottlenecks, infrastructure, labour relations and all the other economic forces that move markets. These will increasingly take precedence over the Central Bank and regulatory siege mentality and extraordinary monetary policy, QE and its devilish derivatives that have distorted markets these last 10-years.

And it’s global. We’ve been moving to this point for a while – since the Fed kicked off with hikes in 2015. The short-end of the US market is normal. It’s been global demand for US bonds (driven by BoJ and ECB rate policy) that held down US long rates and flattened the curve. That is now normalising as the rest of the global economy lines up behind the US and starts to grow – Global Aligned Macro Policy! Yep, I even agree on the “global synchronised growth” tag every other strategist is now so blithely throwing around..

In terms of returns, this is going to favour risk assets. AS LONG AS WE DON’T GET A DESTABILISING BOND SHOCK! Growth forecasts are rising – justifying stock market valuations. We’ve even got apparent strength in commodities – witness oil’s gains and news flow. (And oil is worthy of a whole screed of articles to figure out where it’s going.)

I asked my macro economist Martin Malone to put this fundamental shift-point into context: over the past 10-years of “crisis recovery phase” we’ve seen global central bank balance sheet growth, economic growth, plus financial assets (bonds and stocks) put some $100 trillion on the global balance sheet. Stocks are over half that gain – a fact we should not lose sight of. For all my complaints about central bank distortions, global QE is far lesser around 14%. Martin concludes the unwind of central bank intervention can be more than balanced by continued double digit gains from stocks as normalised economic activity picks up, fuelled by the ongoing ultra-low rate and easy global financial conditions?

So if we’re now in the new economic phase, is this the boom time? Martin thinks so! He’s was bullish all last year, and called the rise in global stocks on the nail. Now he’s saying: “Max short nominal bond, max long inflation linkers, long credit risk and max long stocks” as his base calls, predicting “ significant returns as low volatility allows maximum leverage across investments.”

What are the risks within this bright new world? Of course, it never goes quite as smoothly as we’d like. There are clear risks that could derail the process. Confidence is a fickle friend. There are political risks just about everywhere. It will take you about 30 seconds to search the internet to find analysis on the likely effects of Theresa May’s government falling (rise in sterling on hopes for a second referendum (really?), or Trump not making the end of his term, or Italian Elections, too early a shift in ECB policies killing a very porcelain-like European recovery. Or an Oil Shock. Or a Climate Shock. Yep. If you want to stay awake all night, then there is plenty not to sleep about.

But, perhaps the news risks are very different. The pace of change of disruptive technical society change is faster than ever before. We’d never heard of UBER just a few years ago. What new approaches are going to change markets? How disruptive and entrophic will blockchain and evolved cryptocurrencies prove? And what about society – how long before the masses rise up to income inequality, or we see a return to the labour strife that characterised my childhood?

Meanwhile, back on planet Here-and-now; I read a fascinating article in the Pink-un about the current German economic miracle – apparently, most of Europe expects it to go for ever and a day. There are only a few doubters. Pretty much the same debate within the ECB as the pressure mounts for ending extraordinary policy as Europe normalises.

The article reminded me of the Minsky Rule: “Prolonged periods of stability lure investors and bankers into ever riskier behaviour that ultimately triggers a collapse”.

Hyman Minsky spent his career unravelling the whys and wherefores of financial crises – concluding speculative investment bubbles are part of the normal life cycle of fragile market economies. I might be deeply flawed bond trader, but understand enough to realise markets drive the often irrational behaviour of participants. It’s that uncertainty, driven by “Headology” of market inter-reactions, that makes economics the dismal and unpredictable science it is.

(For more on Headology I suggest you put down your economic text books and consult Terry Pratchett – its much more interesting. For example, his theory of “Socioeconomics Unfairness”: The reason the rich are rich is because they spend less money: a rich man buys a pair of good boots that cost £50 and last 10-years while a poor man will spend a £100 on cheap boots over the same period, and still have wet feet.)

Out of time and back to the day job… Watch the Bond Markets….

Bill Blain