And They’re Off!

IBOSS Market Update August 2019

We regularly hear the statement “There is no value left in Bonds”. Ironically, we do not hear the same said of equity markets despite their trading at record highs. The ‘no value’ point misses a very key issue and one we have been highlighting since the US 10-year yield briefly reached 3%. There is a global race to the bottom in interest rates, which could take yields of all bond duration’s (including the US) to 0%. The starting gun for the latest leg of that race was fired after the Powell pivot at the end of December 2018. He effectively rowed back on the hawkish statements he made only a few weeks earlier.

The race to the bottom is unlikely to be run in a straight line, these things are never straightforward, but the reason we are confident in our prediction is that politicians and central banks are currently aligned in their thinking. They believe that the way to stimulate growth and the much sought after, but illusive, inflation is to keep cutting rates or pushing interest rates and bond yields into ever more negative territory, a position we have seen in Japan and much of Europe. It was said by many that when German 10-year paper hit 0%, then the value was gone. We know now that wasn’t the case, as rates are now circa -0.5%.

In our opinion the policies of the central banks, egged on by politicians and institutions like the IMF, are flawed and often seem to be based on maintaining stock market levels. Applying more of the same medicine to a patient who is obviously not responding will have the same outcome, but the symptoms will persist. What’s worse is that the patient will deteriorate due to a lack of effective medicine. In the US, which has unarguably the most important bond market, the situation is even more extreme as they have a president who harangues the allegedly independent central bank to cut rates on an almost daily basis.

“Don’t fight the Fed” is an oft used expression. We feel you can broaden this out and increase your conviction by saying don’t fight the world’s central banks and politicians, and that means higher bond prices.

Bull Points

  • Central banks continue to think lower interest rates are the answer, supporting bond prices
  • There are still some positive yielding bonds to buy, especially in the US and UK

Bear Points

  • Any historic mean reversion could lead to substantial losses in either corporates, Sovereigns or both
  • Central banks cannot avoid a recession indefinitely and defaults pick up, especially in high yield