Friday, November 11, 2016

Repost: "Not Bullish On Bonds"

Key points from bearish bonds post in May 2016:

  • Trump essentially says that he would grow the national debt - he's a developer and he loves low interest rates!
  • It is very, very nonlinear, because once bonds lose momentum, who will want to own them? Professional asset management and retail investor sentiment are both all about momentum. 
  • Every credit - government or corporate - looks much worse with rising interest expense.
  • We will come to realize that a lot of stuff in the economy (junk bonds, private equity) was part of a virtuous interest rate cycle.
  • QE invariably caused rates to rise, and you could (and we did) make money buying bonds every time the Fed stopped buying them. The QE bond purchases may have been respectably large in relation to the flow of debt issuance, but they were puny in relation to the stock of $60T of dollar denominated debt. It freaked creditors out about inflation.
  • The next crisis is going to come in the investment that is currently perceived as riskless enough for highly leveraged institutions like banks to buy. Right now, government bonds are accorded zero risk in calculating bank capital ratios. The idea that government bonds are riskless when governments are planning to flood the market and when the expenditures are consumed (building no collateral) may prove to be the latest extraordinary popular delusion
This week has illustrated my point. The election of Trump led to an immediate 25 bp increase in the 10 year bond yield, which means an instant 2.3% loss in value. More than a year's worth of interest.

1 comment:

Nathan said...

Health care and education represent roughly 20% of US GDP, which stands at $18.6T today. If Trump sneezes on either of those two sectors, which depend substantially on public spending, it will have a much larger economic effect than any amount of infrastructure-related fiscal stimulus.

A Trump presidency will create winners and losers across different economic sectors. However, it doesn't necessarily follow that we'll end up with substantially higher inflation or interest rates (cf. Abenomics).

Whereas the inflationary effects of a Trump administration are still hypothetical the real economic effects of a +50 bps increase in yields will be felt immediately in corporate profits (via TWEXB) and real estate (via higher mortgage rates).

Another factor that seems obvious but doesn't get much attention is that the US economy is due for a recession and an incoming president, like an incoming CEO, will prefer to recognize losses quickly so they can be attributed to the previous administration.

So, I still think we see lower rates (but, maybe not new lows) before substantially higher rates.

Having said that, nice call on rates :)