The government is not exactly a paragon of fiscal responsibility – abandoning any semblance of economic wisdom, while bureaucrats joyously spend more money than they take in. A $2.2 trillion spending bill here, a $484 billion stimulus package there, and an additional $350 billion somewhere else. Because of the Coronavirus, the 2020 class of lawmakers is making its predecessors seem like stalwart guardians of the public purse. Legislators continue to throw bags of Federal Reserve Notes, euros, and pounds at the pandemic, and states will flood the global bond market with a fresh supply of debt to fund these extravagant outlays.
This financial arena – which profits off of government waste – was already awash in notes and bills before the coronacollapse, but the tidal wave of bond issuances will leave you wondering if there is enough demand in the global $100 trillion bond market.
A Primer
Bonds are sold by governments and corporations to raise money, whether it is to cover new spending or expand operations. The bond issuer agrees to pay you back the face value of the loan by a specific date. Many investment experts say this is a safe investment, but there is always a risk of losing money on a bond if you sell before the maturity date for less than you paid or if the party defaults.
Bonding with Investors
Ray Dalio, the founder of the world’s largest hedge fund, recently told Bloomberg that it would be “crazy” to hold government bonds now and for several more years. Why? The printing press, baby. His reasoning makes sense: 0% interest rates (or subzero rates) and a lot of currency production. Dalio encouraged viewers to think about how government efforts impact the value of money and how the results of their interventions decide what becomes the “storehouse of wealth.”
A 10-year Treasury with a yield of 0.6%. A 10-year German bund with a yield of -0.47%. A Japanese 10-year note with a yield of -0.013%. You are receiving a pittance for holding these debt instruments. With a spike in price inflation inevitable on the other side of the lockdown, you might need to second guess if it is the right investment decision.
The main factor for the global bond market is supply and demand. In the United States, the White House is debating introducing corona bonds to help grapple with the exploding budget. Reports suggest the Treasury Department is once again weighing century bonds. Elsewhere around the world, governments continue to issue and auction billions in bonds, deducing that there will inevitably be a buyer. And, if there is not an investor scooping up these notes and bills, then central banks will come to the rescue.
With many countries selling bonds, will there be enough of an appetite? For certain markets, such as the United States, Europe, and some Asian economies, there will be sufficient demand to help politicians contain the pecuniary explosion – up until a point.
Everything that is unfolding in the overall financial market defies the space-time continuum. But you cannot expect anything different when millions are out of work, the leading indexes are rallying, and the Fed’s balance sheeting is poised to top $10 trillion this year. This is life in coronaville – fair is foul and foul is fair.
Bubble Bonds
Before the pandemiconomy, the bond market was already in a massive bubble. When the yield curve inversion occurred – long-term bonds possess lower yields than their short-term counterparts – everyone thought that this was a sign of the end of days. What it highlighted was the immense level of central bank manipulation that had taken place – and still does in the coronacrisis. Up until this year, central banks have acquired $25 trillion of securities in about a decade, which causes distortions. Of course, these powerful institutions have pumped more than $23 trillion into financial markets in a little more than a month, which will undoubtedly alter reality on The Street for a long time.
This has not exactly produced excellent results since there are more than $15 trillion in negative-yielding bonds. If you thought subzero interest rates were crazy during the bull market, then just imagine how much lower rates can go throughout this bear market!
For now, the bond market bubble has yet to pop because investors are speculating on central bank rescues. Indeed, the Federal Reserve is buying vast sums of Treasurys, the Bank of Canada (BoC) is purchasing all types of bonds (federal, provincial, municipal, and corporate), and the Bank of Japan (BoJ) is set to launch quantitative easing infinity. It will buy unlimited amounts of government debt, and the list continues. Central banks are driving demand.
Many bonds are purchased on the margin, leveraged by as much as nine to one. That is a terrifying prospect, but with the greater fool theory prevalent, why would anyone care as long as they get theirs? David Stockman, the budget director under former President Ronald Reagan, told eminent libertarian Tom Woods last year:
“I’ll buy that negatively-yielding 30 or 100-year bond. The price today is 150. It’s going to be 190 a couple of months down the road. If anything starts to go wrong, I’ll sell it to the next sucker and pocket my capital gain and move on to something else. That is the very definition of a speculative mania that’s nearing the blow-off stage.”
What is absent in this conversation, too, is corporate debt. While all the focus is on government bonds, analysts tend to forget about the tidal wave of corporate bonds, many of which are on the cusp of default. Or, at the very least, they used to be until Fed Chair Jerome Powell announced the institution’s intentions to buy corporate bonds through exchange-traded funds (ETFs).
Hopping on the Bondwagon
Everyone is hopping on the bondwagon. Netflix is offering $1.6 billion in high-yield bonds, while North Korea has signed off on issuing its debt instruments. In fact, who is not pawning off their debts to help pay the light bill and stock up the cupboard with Kraft macaroni and cheese? Hey, if governments can get away with selling notes and bills at historically low rates (negative rates, even), then that is nice work if you can get it. This is one of the greatest deceptions in modern history: Investors pay for the privilege of drowning in red ink.
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Read more from Andrew Moran.
