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Who Buys Negative Yield Bonds?

This special guest commentary was written by our friend Daniel Lacalle

Who Buys Negative Yield Bonds? - negative interest rates cartoon 07.12.2016

 

The amount of bonds with negative yield in the Eurozone and Nordic countries is higher than $4.5 trillion. The global figure is closer to $9.5 trillion. It is estimated that by the end of 2017, 18% of the Global Government Bond Index will have negative rates.

 

This means paying to lend to governments.

 

But, who buys these bonds and why?

 

Let’s first look at the environment.

 

“Financial repression” is the term used to identify a period of extremely low interest rates and artificial depreciation of the currency. It is the assault on the saver that involves diluting the value of money and its price with the questionable objective of forcing – hence the word repression – citizens to stop saving, and resume consumption and investment.

 

The peak of financial repression is real negative rates. Advocates of this practice justify it from the fallacious argument that saving is bad and that what you have to do is force economic agents to spend. If money is worth nothing, consumers will prefer to consume and companies will use their surpluses to invest even if profitability is poor.

 

However, it does not happen. Because many of these countries have exceeded the debt saturation threshold, with more than 225% of GDP of total public and private debt. Thus, financial repression achieves the opposite of what it intends. More repression, more saving, because economic agents perceive that overcapacity and debt remain as burdens and that the price and quantity of money is artificially manipulated.

 

Contrary to what the New Keynesians belief, extreme financial repression leads to even more cautious actions by economic agents in the real economy. A period of financial repression such as the present one, leads families and companies to save much more. Preferences remain focused on being conservative in the face of increasing uncertainty.

 

Why do citizens become more risk averse amidst expansive policies? Why do companies not invest more in the face of low interest rates and extreme liquidity?

 

Because they do not trust the economic environment and the reality they see differs from the sugar coated central bank-created image. Because the certainty of tax increases and the fragility of economies is not disguised by manipulating the amount and cost of money. Governments that increasingly consume more resources from the real economy make household consumption and private investment a high risk.

 

So who buys bonds with negative returns?

 

  • Someone who thinks that the stock market and risky assets are going to collapse due to the liquidity saturation of expansionary policies and their low impact in the real economy. Therefore, faced with the possibility of losing 1% in a bond compared to losing, say 20-30% in the stock market or commodities, their preference is obvious.
  • Those who assume that countries that do not participate in currency wars will see a strong currency relative to the one in which they invest. Say you buy Nordic bonds with negative yields and the local currency strengthens relative to the USD. The bond will be worth more from the currency move.
  • Those who think that governments and central banks know how to get into quantitative easing, but have no idea how to get out. For this reason they expect to see further reductions in interest rates and more monetary expansion plans, which will revalue the low risk bonds further.
  • Those who analyse these expansionary policies and currency wars and, instead of seeing inflation risk, estimate a greater deflationary probability, as the preferences for consumption and investment will not improve, they may worsen due to the lack of trust in central banks.

 

In short, contrary to what New-Keynesians believe, extreme financial repression leads to even greater caution -saving and divesting- . Meanwhile, the fragility of economies may increase if disposable income continues to be taxed away.

 

Financial repression only achieves the opposite of what it seeks to achieve. All it creates are short-term bubbles in risky assets.

 

Now, inflation is rising, causing a massive loss in nominal and real terms for those who invested in low yield bonds. This will impact pension funds, and at the same time central banks remain behind the curve unable to raise rates and moderate money supply. The recipe for stagflation.

EDITOR'S NOTE

This is a Hedgeye Guest Contributor note written by Daniel Lacalle who is an economist who previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial MarketsThe Energy World Is Flat and forthcoming Escape from the Central Bank Trap."


Caterpillar (Best Idea Short): Is It Really A Fraud? - Flash Call

Caterpillar (Best Idea Short): Is It Really A Fraud? - Flash Call - caterpillar best idea

 

The Hedgeye Industrials Team – led by Jay Van Sciver – will discuss their Best Idea Short thesis on Caterpillar (CAT) today at 12:30pm ET.

 

With the recent IRS raid on Caterpillar corporate offices and some strongly worded reporting on CAT's tax and accounting practices, which included an accusation of fraudulent activity, investors should be increasingly concerned about the investment risks associated with CAT shares.

 

Email sales@hedgeye.com for more information.

KEY DISCUSSION POINTS

 

  • REGULATORY AGENDA Reporting during ConExpo and highly visible corporate raid calibrated to drive strong bargaining position in settlements, but targeting reputation may backfire
  • CHASTENED ENFORECEMENT Transfer pricing enforcement has been met with limited historical success, a reality CAT's advisors are likely highlighting
  • UNDERSTANDING RECENT SHARE PRICE RESILIENCE Policy hopes haven't been the only cause for relative strength in CAT shares, but support appears to be fading
  • PART OF BROADER CAT CULTURAL ISSUES CAT already has other investigations on accounting, unusual environmental violations, and exceptionally poor acquisition due diligence (e.g. Siwei) point to a weak corporate culture. 

CALL DETAILS

Ping sales@hedgeye.com for more information. Please note if you are not a current subscriber to our Industrials research there will be a fee associated with this call. 

ABOUT HEDGEYE

Hedgeye Risk Management is a leading independent provider of real-time investment research. Focused exclusively on generating and delivering investment ideas, the firm combines quantitative, bottom-up and macro analysis with an emphasis on timing. 

 

The Hedgeye team features some of the world's most regarded research analysts - united around a vision of independent, uncompromised real-time investment research as a service.


CCL: A Hedgeye Best Idea Short - Conference Call

CCL: A Hedgeye Best Idea Short - Conference Call - z carv

 

Our Gaming, Lodging & Leisure Team -- led by Todd Jordan -- is hosting an institutional conference call and slide deck presentation to discuss their Best Idea Short thesis on Carnival (CCL), the American-British cruise company and the world's largest travel leisure company. The call will take place on Thursday March 9th at 11am ET. 

 

We believe expectations remain high for 2017 – the valuation resides at the higher end of normalized, historical averages. And while expectations are for CCL to raise its 2017 yield guidance, several less known offsets need to be considered. 

 

Email sales@hedgeye.com for more information.

 

KEY DISCUSSION POINTS

 

CHINA - MAJESTIC LIFT NOT GOOD ENOUGH TO OFFSET COSTA

It will be another four months before Majestic Princess's inaugural voyage out of Shanghai. Majestic pricing was hot out of the gate but has decelerated significantly in the past 2 months. More concerning is the Costa China brand which is heading for a double digit decline in pricing. The ban on South Korea tours, stemming from the icy relationship between South Korea and China, adds more uncertainty for China cruising.


CCL BRAND WEAKNESS IN EUROPE

Surprising pricing pressure for certain CCL UK/ Europe brands suggest heightened promotional activity to drive bookings. The Italian referendum may be having a delayed impact on some Costa itineraries while Brexit (6 months later) may be finally impacting pricing & booking trends for P&O UK and Cunard brands. In addition, weakening consumer sentiment in Italy and the UK may indicate further downside risk.


BIG WAVE BUT ZIKA REEMERGENCE COULD IMPACT CLOSE IN PRICING

Wave Season finished up nicely with a big February boost in Caribbean pricing for 2H 2017. CCL's staggered, short CarnivalDays promos were normal promos; in other words, no additional incentives were offered to cruisers during Wave Season. We estimate Caribbean pricing fleetwide to be up 7% YoY for FY 2017 - a little above Street expectations. We've done more work on Zika and fear that warmer weather could bring a similar Zika outbreak to last year, which could impact close-in pricing. Already, a scatter of Zika cases have popped up recently and insecticides may be proving ineffective. 

 

CALL DETAILS

 

Ping sales@hedgeye.com for more information. Please note if you are not a current subscriber to our GLL research there will be a fee associated with this call. 

 

ABOUT HEDGEYE

Hedgeye Risk Management is a leading independent provider of real-time investment research. Focused exclusively on generating and delivering investment ideas, the firm combines quantitative, bottom-up and macro analysis with an emphasis on timing. 

 

The Hedgeye team features some of the world's most regarded research analysts - united around a vision of independent, uncompromised real-time investment research as a service.

 


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Don’t Fight The Data. Don’t Fight The Tape. Don’t Fight The Fed

Don’t Fight The Data. Don’t Fight The Tape. Don’t Fight The Fed - money falling

 

Global growth is picking up. Meanwhile, "hedge funds are bracing for a market selloff," citing peak stock market valuations and bloated Trump policy expectations. Talk about cognitive dissonance.

 

But don't fret. We think money managers aren't long enough based on how good the fundamentals have been. Here's why.

Why is the U.S. Stock Market heading higher?

As we've noted before, valuation is not a catalyst. To get the direction of macro markets right there are three key catalysts that we watch: economic growth, inflation and earnings. We're watching whether each of these factors is accelerating or decelerating in rate of change terms (year-over-year growth). 

 

On that score, the global growth picture is clear as day. Case in point, let's take a look at one component of our economic growth analysis for all countries around the world. As you can see in the Chart of the Day below, manufacturing and services PMI readings have been almost universally accelerating recently. It's a sea of green.

 

If you can't read the chart here are some key takeaways from Hedgeye Senior Macro analyst Darius Dale in today's Early Look:

 

  • Of the 32 countries and economic blocks that release monthly Manufacturing PMI data, all but five of them are accelerating on a trending basis.
  • Of the 19 countries and economic blocks that release monthly Services PMI data, all but two of them (India and Mexico) are accelerating on a trending basis.
  • Of the 19 countries and economic blocks that release monthly Composite PMI data, all but one of them (India) is accelerating on a trending basis.
  • The mean reading for each of the aforementioned 70 indicators is in the third quartile on a trailing twelve month percentile basis, which would imply not only are most PMI readings tracking higher, but also that they are elevated in an absolute sense with ample room to run.

 

Don’t Fight The Data. Don’t Fight The Tape. Don’t Fight The Fed - 03.08.17 Chart of the Day

Bottom Line 

Here's a final message from Darius: "Don’t fight the data. Don’t fight the tape. Don’t fight the Fed. Simple enough, eh?"


McCullough: Wall Street’s Fed Rate Hike Nonsense

 

Two weeks ago, Wall Street seriously doubted the Fed would raise rates at its March meeting. The skepticism is a matter of public record (see for yourself). The market expects that line of thinking will prove wrong, as Hedgeye CEO Keith McCullough noted today on The Macro Show:

 

“A lot of people said ‘Well, the Fed’s not going to raise rates.’ Two weeks ago, the market implied a 34% probability that the Fed raises rates. You know what that probability is this morning? 96%.”

 

Why the sudden change?

 

For starters, the regional Fed heads made the rounds with TV talking heads last week, which was later interpreted as lobbying for hawkish monetary policy.

 

Here’s a round-up of some of the comments:

 

  • "The case for monetary policy tightening has become a lot more compelling," New York Fed President William Dudley told CNN last week. "After the election we've seen very large increases in household and business confidence, we've seen very buoyant financial markets."
  • "In my view, a rate increase is very much on the table for serious consideration at our March meeting," San Francisco Fed President John Williams said in a speech last week. “The aim is to keep the economic expansion on sound footing — not too hot, not too cold — that can be sustained for as long as possible.”
  • "I see three hikes as appropriate for 2017, assuming things stay on track," Philadelphia Fed President Patrick Harker said in prepared remarks at Temple University last week.

 

Chief Fed head Janet Yellen joined the party last Friday saying, “Indeed, at our meeting later this month, the committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate." (emphasis added)

 

The 10-year Treasury yield went from 2.35% to 2.51% on the rate hike speculation. We’ve been advising investors to sell Long-Term Bonds (TLT) for some time now, since the U.S. economy is heating up (click here for more).

 

What could push long-term bond yields even higher? A strong jobs report, McCullough says. Last month was the first year-over-year jobs growth in 23-months.

 

“If we were to see another acceleration in nonfarm payroll growth I think you could see the 10-year tap 2.55% or higher.”


Cartoon of the Day: Poo Bear

Cartoon of the Day: Poo Bear - 03.07  X

 

Even with this week's modest "correction," stock market bears are really stepping in it so far in 2017.

 

 

Click here to receive our daily cartoon for free.


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%
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