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Investors: Be Wary of Bear Trap Panic in 'Rigged' Bond Markets

Investors: Be Wary of Bear Trap Panic in 'Rigged' Bond Markets

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Thursday, 11 January 2018 07:19 AM Current | Bio | Archive

U.S. Treasury yields have simply soared to, in today’s context, the depth-defying heights of 2.55 percent, 2 days in a row so far this year.

A carnage in the world’s fixed income market that to many seems almost incomprehensible.

Anyway, in the Financial Times we read: “Jeffrey Gundlach, the founder of DoubleLine Capital who is a closely followed bond investor, lent his weight to the bearish sentiment, saying central bank policy was shifting to an “era of quantitative tightening” and Bill Gross, the so-called bond king, declared publicly that his funds were short selling U.S. Treasuries.

On the other hand, those of us that are old enough to remember the bond bear market of the early 1990s when Treasuries rose from 5 to 8 percent are perhaps a little bit less impressed by the panicked headlines of the financial media. Of course, the early 1990s did not have the world of #hashtag economics to sensationalize everything.

The reported triggers behind the move: “China may be possibly not buying, but not selling (!) U.S. Treasuries” and the realization that central banks are in fact slowly tightening policy, underscore the changed nature of the bond markets.

Investors should keep in mind that bond markets are not driven by pure free market forces.

Bond markets are “rigged.”

Domestic central banks are a captive investor in bonds for so long as they pursue quantitative policies.

Foreign central banks are, to all intent and purposes, a captive investor in bonds as long as they hold foreign exchange reserves.

Neither investor is choosing to buy bonds in preference to other assets as a result of relative return analysis, and this distorts the real yield and therefore the bond market.

Yesterday’s move of course led to a slightly steeper yield curve with the gap between the 10-year yield at 2.55 percent and the 2-year yield at 1.98 percent increasing a little bit.

Does this mean that expectations of economic growth have dramatically improved?

Of course, it does not.

There is absolutely no reason to suppose that anyone’s economic expectations changed at all yesterday.

The yield curves so-called predictive power for economic cycles was a coincidence generated in the times when we had a high-inflation environment.

In a low-inflation environment, it’s “real” yields that weigh most heavily in bond markets and as the bond markets are rigged, real yields have little or no correlation with the economic cycle.

In the United States, today we have the release of the producer price inflation (PPI) numbers.

Now, producer price inflation (PPI) matters as a signal of corporate price power. Companies sell to other companies and not to consumers.

Moreover, producer price inflation has been a signal of rising corporate pricing power. The growth has been steadily picking up for a couple of years, indicating that companies are able to pass on some of their cost increases at least.

Moreover, while purchasing managers surveys (PMIs) are sometimes thought to be meaningless noise that serves no purpose other than keeping television anchors and employment, the pricing components of purchasing managers surveys are a reasonable indicator of corporate pricing power. Corporate pricing power has been improving in recent months. This is hardly a hyper-inflation environment, but nevertheless, it is showing that companies are not trapped in an especially low-inflation world.

Meanwhile, China is attempting to stop cryptocurrency cash printing on the not unreasonable grounds that it takes quite a lot of electricity to produce the speculative bubble.

China’s energy problems have been compounded by its water crisis, water being a rather important factor in cooling power stations, leading the Chinese to take efforts to improve energy efficiency.

Letting energy efficiency for what it is, I don’t think it’s an overstatement to say that the cryptocurrency bubble seems a rather obvious target.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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Investors should keep in mind that bond markets are not driven by pure free market forces. Bond markets are “rigged.” Domestic central banks are a captive investor in bonds for so long as they pursue quantitative policies.
investors, bond, market, bear, trap, china
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2018-19-11
Thursday, 11 January 2018 07:19 AM
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