Archive for the ‘Bonds’ Category

The Fed’s Abnormalization Plan

Monday, June 26th, 2017

The Federal Reserve Board has issued an addendum to its “Policy Normalization Principles and Plans” for reducing its bulked up $4.5 trillion portfolio, but there’s nothing normal about unloading $4.5 trillion in bonds.

That’s a lot of bonds.

The Fed’s policy, which virtually no one has read since it was issued in November 2014, is an update of its 2011 normalization policy, which no one read. It crams quite a few words into a single page, which we would summarize by saying that the Fed hopes to unload as much of its bond holdings as it can without causing the bond market to collapse.

Fed Will “Cease or Commence”

In case you don’t believe me, here’s a sample paragraph: “The (Federal Open Market Committee) expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.”

Note the “cease or commence.” In other words, the Fed will either stop buying bonds to keep its portfolio close to $4.5 trillion or it won’t. Talk about commitment issues! (more…)

Rates Rising, Yet Bond Buying Sets Record

Monday, April 17th, 2017

Rising interest rates, higher inflation and tighter monetary policy should be bad news for bonds. Yet investors have been buying record volumes of new bonds.

  • Highly rated U.S. companies issued $414.5 billion of debt during the first quarter, a record for any quarter.
  • Dealogic reported that companies and governments in emerging markets sold $178.5 billion of dollar-denominated debt in the first three months of the year, the best first quarter on record.
  • U.S. companies with junk-bond ratings issued debt totaling $79.6 billion, double from a year earlier.

Why are bonds so popular now?

Economic growth remains uncertain. There’s been plenty of good economic news of late.

Chart from Motley Fool. Numbers are in millions of dollars.

The unemployment rate fell to 4.5% in March – or 8.9% if you use the U-6 rate, which even Fed Chair Janet Yellen seems to finally agree is more accurate. The labor force participation rate, which was 62.6% on November, has nudged up to 63%. New orders are up, capital expenditures are up and housing starts are up.

Yet there’s still plenty of uncertainty about the economy, which could be affected by actions in the Middle East, Russia, Korea or elsewhere.

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Bet You Can’t Count to a Quadrillion

Monday, May 18th, 2015

When someone uses “quadrillion” in a headline, you know you’re in for a bit of an alarmist rant. We’re talking 1,000,000,000,000,000, which, stated another way, is a thousand million million.  Or a million billion.  Or a thousand trillion.

Stated in dollars, that’s more than the debt racked up by the federal government since President Obama took office.  Way more.  It’s even way more than the Federal Reserve Board spent buying bonds when it was in QE mode. Chart 1

So when Bill Holter of Global Research wrote an article with the headline, “Derivatives are a $1 Quadrillion ‘Ticking Time Bomb,’ ” it caught our attention.

So did the series of charts he included, which showed movements in the government bond market that were double-black-diamond steep, even without moguls.

We’re talking government bonds here, not junk bonds, not commodities, not emerging market stocks.  Government bonds are Nebraska – flat and predictable.  During volatile times, they’re the bunny slope, not a double-black diamond.

So what’s up with the volatility?

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The Markets Need Psychotherapy

Monday, December 15th, 2014

“The whole idea that the stock market reflects fundamentals is, I think, wrong.  It really reflects psychology.  The aggregate stock market reflects psychology more than fundamentals.”

Robert Shiller, Nobel Prize-winning economist

Tired of low returns?  You may be a bond investor.

Bond investors have been “growing tired of low returns, the endless warnings that rates are about to rise, and constant reminders of the dangers of riskier bonds,” according to Jeffrey Matthias, CFA, CIPM of Madison Investment Advisors.

At the same time, they’ve watched the stock market continue to break new records every time there’s another sign that a central bank somewhere may buy a few bonds or lower interest rates into negative territory.

“None of us have ever lived through this kind of extreme, long-lasting suppressed rate environment,” Matthias wrote, and, as a result, those bond investors who are mad-as-hell-and-are-not-going-to-take-it-anymore have been frustrated enough to take on a lot more risk for a little more yield. Central Bank Assets

When you chase yield, you catch risk.  It’s a dangerous reaction to the yin and yang of investing – fear and greed.

“Typically, when markets are moving higher,” Matthias wrote, “most investors turn greedy and want more.  Should an investor’s more conservatively positioned portfolio produce lower returns when the market surges, the investor may regret not having taken more risk.  In contrast, should a riskier portfolio drop significantly in market value, the opposite may happen and an investor may begin to regret (his or her) decision to have invested in risker assets.  This can be accompanied by a fearful overreaction.”

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The QE Apocalypse

Friday, July 11th, 2014

The end is near.

The Federal Reserve Board has now put a date on the quantitative easing apocalypse, letting us know that bond buying will end in October – unless the central bank changes its mind, of course.

The October ending is not unexpected.  The Fed has been cutting back bond purchases by $10 billion a month since last year and it doesn’t take a math wizard to figure out that there will be nothing left to taper post-October.

Yet this news, reported in the just-released minutes to last month’s meeting of the Federal Open Market Committee, is being treated as a revelation.  It was, for example, the lead story in The Wall Street Journal, which typically doesn’t lead with news that was discussed last year and made official at a meeting that took place a month ago. Portugal

The real news, though, is what wasn’t discussed – the end of near-zero interest rates.  As a result, rather than pushing yields up and bond prices down, release of the meeting minutes had the opposite impact.

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Prozac Nation

Friday, June 27th, 2014

It’s all stress-free bliss these days … at least for anyone who’s not paying attention.

Has someone been putting anti-depressants in the water supply?  That’s one way to explain Wednesday’s non-reaction to the report that the economy shrank by 2.9% in the first quarter – not the 1% drop previously reported.

It would also explain continued investor complacency reported last week, with the VIX (volatility index) approaching single digits.  And it would explain the plunge in junk bond yields to 5.6%, which is a full 3.4% points lower than the decade-long average of 9%.

GDP GrowthYet investors showed that they still have a pulse, when they took the Dow down 100 points after James Bullard, president of the St. Louis Federal Reserve, announced that an interest rate hike may take place in the first quarter of 2015.

So consider this in context.  In addition to the slumping economy, we have Russia’s continued takeover of Ukraine, which is now being overshadowed by the continued takeover of Iraq by Muslim terrorists known as ISIS and the possibility of U.S. military intervention.  We have civil war continuing in Syria and continued nuclear development in Iran, in spite of the lifting of sanctions.  We have U.S. veterans in need of medical treatment being ignored while the Veterans Administration fudges numbers.  We have the missing e-mails of Lois Lerner and six other IRS employees who allegedly targeted conservative groups.  We have continuing fallout in the healthcare industry from the pains of implementing Obamacare.  We have a stock market so overblown that price-to-earnings ratios are at levels higher than they’ve been through 89% of the history of the S&P 500.

So what’s moving the market?  A statement made by a Fed board member that repeats a statement he previously made.

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The Market’s Missing Mojo

Friday, June 20th, 2014

Easy money policy has its share of side effects.  The stock market continues to hit new highs, thanks to the Fed, but the level of risk that investors and taxpayers are exposed to also may be close to new highs.

The market for U.S. Treasuries, as one example, is a “risk on” market.  As Bloomberg put it, “Just because U.S. Treasuries look more and more stable doesn’t mean they are.”

Some may mistake a lack of volatility for low risk, but the lack of volatility appears to be the result of less liquidity, not lower risk, as the Fed has purchased trillions of dollars in bonds and banks are pulling back from debt trading. Bubble PE_0

Before the financial crisis, lower volatility resulted in more trading, but in this case trading volume has dropped.

“What’s happening instead,” Bloomberg reported, “is unprecedented central-bank stimulus has sent everyone into the same risk-on bets, while it’s also becoming more difficult to trade as banks shore up their balance sheets in the face of new regulations.”

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Polar Vortex or Recession Redux?

Friday, May 30th, 2014

The recovery that wasn’t a recovery may have come to an end, as the Bureau of Economic Analysis reported that gross domestic product dropped by 1% during the first quarter of 2014.

Even with the drop in GDP, lower housing sales and continued high unemployment, no one is saying the economic is in a recession.  Perhaps when a recovery is as insignificant as the one we’ve experienced for nearly five years, the distinction between recession and recovery is insignificant.

The economy was in sad shape five years ago and it’s in sad shape today, in spite of record stimulus spending, bond buying, and warm and fuzzy messages from the President, Congress and the Fed.

Quarter-to-Quarter-Changes-in-Real-GDP-Percent-Change_chartbuilder-1But fear not.  The bar is so low now, even a baby step over it will look like a high jump.  At least that’s the opinion of PNC Chief Economist Stuart Hoffman who wrote, “I believe this real GDP decline, mostly due to the polar vortex, coiled the ‘economic spring’ even tighter for a sharp snap-back (boing!) this quarter, where I have an above-consensus forecast for a 4.0% annualized rise in real GDP.”

In other words, bad news for the first quarter is good news for the second quarter.  Stop me if you’ve heard that story before.

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The Fed Goes Long

Friday, April 18th, 2014

Few investors today would consider investing in long-term Treasury bonds.

The yield curve, which measures the spread between interest rates for short-term and long-term bonds, is not as flat as it has been in recent years, but that’s faint hope for investors.

A 10-year Treasury is still yielding less than 3% interest.  If the Federal Reserve Board achieves its goal of pushing inflation up to 2%, the real interest on a 10-year bond purchased today will be under 1%, payable at maturity.yield-curve-investwithalex

If the Fed overshoots its goal and inflation moves higher, which is highly likely, a 10-year bond would produce a negative yield.  What’s the probability that inflation will remain lower that the current yield on a 10-year Treasury over that entire period?

The U.S. has not had a period when inflation remained below 3% for a 10-year period since the days of the Great Depression.  During the period of recession then slow growth that we’ve experienced since the financial crisis began in 2008, inflation has remained low and the Fed’s focus has been on fighting deflation.  But when the economy improves and normal growth returns, inflation is likely to move significantly higher, as higher inflation is a byproduct of a healthy economy.

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Think Like a Rat

Friday, March 28th, 2014

Experiments show that if you put rats in a maze and give them a jolt of electricity when they go the wrong way, they will eventually go the right way.

Apparently, humans may not be that smart.Two white laboratory rats in a maze

OK, we’re smarter than rats.  We know better.  But we believe what we want to believe.  And right now, a majority of those who invest believe the “trend is our friend.”

We forget that what goes up must come down, regardless of how many bonds the Fed buys.  It’s a scary world and no amount of irrational investor confidence can keep the market aloft forever.

In the first decade of the new millennium, we lived through two difficult bear markets, each of which chopped stock prices nearly in half.  The bear market of 2000 to 2003 was caused by the irrational belief that tech stock prices moved in only one direction.  The bear market of 2007 to 2009 was caused by the irrational belief that housing prices moved in only one direction.

So here we are just five years removed from the last bear market and investors are acting as though stock prices move in only one direction.  Investors have already forgotten that bubbles burst.

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