It's difficult to think of a more politically incorrect idea than recommending investors to allocate money to China's government bond market, ostensibly by selling a portion of their U.S. treasuries. Granted, this would actually be consistent with the rebalancing of the bilateral U.S.-Sino trade relationship that the most ardent critiques of China's economic model desperately want. Or perhaps what they really want is a strong dollar plus capital controls? It is difficult to tell sometimes. That said, it is fair to say that lending money to China's government to fund domestic investment, some of which invariably will go to defence, probably doesn't get you on the White House's Christmas list. Incidentally, and before I flesh out the trade, I should make one thing clear. I think the mismatch between the increasingly tense geopolitical relationship between China and the U.S., and the fact that capital and goods still flow more or less freely—with the exception of direct outflows from China's mainland—between them represent an enormous tail risk for markets.
Read MoreIt’s been a while since I looked at markets, as I am busily trying to finish the second chapter of my new demographics project—see here—but peering across my portfolio, I haven’t missed much. Granted, the straight-line rise in green and clean energy stocks—a theme that I am invested in—has petered out, but otherwise, most of what I own keep going up, and the number at the bottom of the column keeps getting bigger. Investing in a pandemic-stricken world, it seems, isn’t too bad. When I haven’t looked at markets for a while, I tend to go back to the basics. The first chart below plots the six-month stock-to-bond return ratio in the US, which has been locked at +20% since the beginning of the fourth quarter. This is punchy, even unprecedented, but I am loath to second guess this trend at the moment. Sustained positive stock-to-bond returns tend to be associated with resilient bull markets, and let’s be honest; that’s what we have, for now. I worry, as I suspect does everyone else, that investors have bought too aggressively into the rumor of a post-virus recovery, implying that they will sell the fact. If that’s true, conditions will become more difficult over the summer, and in the second half of the year, though I am inclined to believe that any swoon will a familiar case of BTFD™.
Read MoreI’ll keep it short this week, mainly because I don’t have much new to say. I continue to think that the tug-of-war between markets and monetary policymakers in fixed income markets remains the key spectacle to watch, even if I concede that we have been watching it for a while. There are economists and strategists who will tell you that policymakers are perfectly happy with steepening yield curves, and that they in fact welcome them. To believe this, however, requires that you forget the initial stages of the pandemic-policy response in which central bankers solemnly pledged to print as much money as needed—via QE—to keep rates pinned across all maturities in order to support the monumental fiscal efforts needed to prevent economic disaster. If you’re telling me that this tacit agreement is now broken on the eve of the new US administration is about to shovel €1.9T into an almost fully vaccinated economy—that’s just shy of 10% of GDP for those wondering—I have to concede that yields can, and likely will, move a lot higher. But is that really what you’re telling me? It seems to me that observers have quietly pivoted towards the idea that central banks obviously accept, even want, higher bond yields to reflect the recovery. I am sorry, but that doesn’t pass the smell test. While a steepening yield curve sows the seeds of its own destruction via an ever more attractive roll and carry, especially with fwd guidance on the front end, there is always a risk that markets end up questing the commitment to low policy rates.
Read MoreFirst things first, I am GBP-based investor, which means that I need to think about both the value of currency and asset, when I dip my toe into US financial markets. With GBPUSD pushing 1.40 and the US 10y motoring bast 1.5%, I had to do something last week, and that something was to buy some duration in the US. I thought that I’d put that up front, because in what follows, I will sound like a broken record It is now getting feisty in bond-land. The sell-off in US duration got rowdy last week, and is now starting to pull up bond yields in Europe. What’s more, front-end curves are steepening too, which is to say that markets are now trying to bring forward rate hike expectations into market-relevant forecast horizons. As I have explained on these pages since the beginning of the year, investors and strategists are still debating whether this is all part of the plan—reflecting a desired increase in growth and inflation expectations—or whether it constitutes an undue tightening in financial conditions. Market observers remain undecided, partly because policymakers can’t seem to figure out where to draw the line either. Higher bond yields are good, so long as they don’t become a constraint on the recovery via a tightening of financial conditions. In principle, there is nothing wrong with this position, though it also invites the situation we now find ourselves in. Put simply, yields will motor higher until something breaks, or until policymakers call it quits.
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