Bonds Are Not In A Bubble
BUSINESS INSIDER: What is the most exciting trade out there right now, in your opinion?
STEVE FEISS: I would suggest watching the 5s30s spread as we start off the week thinking about the geopolitical landscape, which is code for risk on/off relating TO U.S. (lack of) response to Crimea vote. Then, mid-week we'll get our first Yellen-led FOMC meeting and press conference. While I had been thinking some sort of steepening (concession) might have helped place last week's durational supply, that turned out NOT to be the case and, along with some other factors (positions, economics - more on both in a min), combined to keep curve's flattening momentum in place. It seems that risk-off fixed income rallies benefit the longer end, while any perceived FOMC hawkishness has hit the front end and created what's been a one-way trade since the end of November. When this changes, or more importantly, WHAT changes this dynamic, will be something exciting. Not sure at this point what that is going to be.
BI: Of the divergences between normally-correlated assets that exist in the marketplace right now, which do you find most puzzling or inexplicable?
SF: The bid for peripheral debt in the euro zone driving yields down and spreads in continues to boggle my mind. While I fully understand the reach for yield created by a global zero interest rate policy, it seems to me that euro zone fixed income market dynamics were healed by ECB's Draghi offering those three famous words, "Whatever it takes," back in July 2012. The way in which U.S. Treasuries continue to grind lower in yield and flatter in curvature (5s30s) even as lower-rated peripheral debt does - like nothing's ever happened AND as if they are a good alternative to generate SAFE, government bond yield - is a perfect example of how risk on and off CAN peacefully coexist if you look hard enough?
BI: Which developments in global financial markets, if any, would you flag as most concerning for risk appetite?
SF: While central bank balance sheet normalization here in the U.S. is of great concern, I'll also continue to watch how the political economy shapes up into the midterms and then 2016. The current administration has very good reason for concern and while I may NOT agree with solutions currently being offered, as I look at bigger-picture trends, it seems that big central bank balance sheets aren't all we thought they were cracked up to be. At least not economically speaking. Coincidence that just six years ago, Bear Stearns was given TO JPMorgan for $2, then $10/share? In that I don't have THE answers and it's much easier to be critical, I'll refrain from politicizing a market view and again, would note great concern IF trends like that in retail sales persist, unaffected by central bank balance sheets and fiscal policies.
BI: What do you perceive to be the most misunderstood trend or event in or characteristic of today's markets?
SF: Low rates meaning bonds are in a bubble. I'm biased as a bond guy but offended almost daily at the flagrant misunderstanding that is "sold" to/through mainstream media regarding the association of low rates with an asset class that is in a bubble. U.S. Treasury rates are as much a "future" discounting mechanism as are the equity markets. What were stock prices thinking back in 1999? Exactly WHAT multiple were they OK with, again? How'd that work out? While I get that low rates hurt savers and retirees, simply selling low rates as a bubble like tech stocks were in 1999 seems to leave out the discussion/distinction between components OF the fixed income markets as well as the fact that as a country, we generally speaking like buying cheap stuff at Target and Wal-Mart. And as long as that continues, China will continue to have an abundance of U.S. dollars, and so will continue to be natural buyers OF our U.S. Treasuries. Low rates are likely here to stay for quite a while. Still. Like it or not...
BI: What pieces of new information (e.g. economic data releases, FOMC, price action in a given market over the next few days/weeks, etc.) do you think have the biggest potential to alter your outlook?
SF: If/when fixed income (and U.S. Treasuries, specifically) positions change, we'll want to know. We learned that as of the end of February, PIMCO had decreased the number of govies held in the total return fund (tweeting about NOT buying what the Fed will buy less of). Lost in the headlines is that it seems they did so in a curve-steepening fashion. They've allocated "-3%" towards the longer end of the curve (so a SHORT) while having "47%" in the 3-5yr sector, a.k.a. the belly. Carry and roll down the curve is powerful, to be sure. We ALSO follow weekly input from JPMorgan clients (reported with a week lag) and similar input from Stone & McCarthy (SMR) who, by and large, continue to indicate a short base in the fixed income arena and very little U.S. Treasuries allocation. Finally, we continue to follow Great (un)Rotation proclamations by the bulge bracket firms and covering pension systems over the years, know there are lots of moving parts TO the liability-driven investing (LDI) game. Matching of one's assets TO their liabilities matters. Eventually. I'll keep wondering IF the last bout of curve-flattening has been just that ... a partial unwind of the "pain" trade that has seen steepeners stopped out and under-allocations remedied to some degree. See any number of Great (un)ROTATION notes from BofAML regarding pension funds taking equity profits and plowing them back into fixed income. In any case, as stocks remain at/near record highs and pension deficits, generally speaking, are much narrower now thanks to record-high equity prices, we can't imagine where U.S. Treasury rates might be if/when equity markets were to take some (more) chips off the table. Clearly this relates back to the question/response just above and low rates NOT equating to a bubble, just because...
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