Illustration: Michael Mucci
The US bond market is the biggest in the world. At roughly $32 trillion, it dwarfs the sharemarket. It is the mother.
And so it was that when Bill Gross declared this week that he had dumped US bonds from his investment portfolio, he scared the daylights out of traders around the world. Gross is managing director of Pimco, the world’s biggest bond fund.
”It’s not a question of dissing the United States or questioning the credit of the United States, but simply a maturity reflection,” said Gross.
Bonds, or Treasuries as they call them in the US, were ”mispriced relative to the inflationary environment and the growth we see ahead, and there are better alternatives in order to capture yield”.
Gross is first and foremost an investor. The yield on a US bond was simply too low, he said, compared with the likes of Mexico, Brazil and Spain, as the US Federal Reserve was buying bonds itself and forcing yields down. Bear in mind that, with bonds (paper issued by governments to raise money) the price is inverse to the yield. So, if the price of a bond goes up, the return to the investor goes down.
But implicit in Gross’s remarks was criticism of government. Too much “quantitative easing” – expanding the money supply that is, as Washington issued bonds to fund its deficit and the Fed bought them, rendering the yields artificially low.
That’s right, the US is buying its own debt, with its ears pinned back. “Quantitative easing” (QE) they call it – a euphemism for printing money in a desperate bid to get people spending, appease Wall Street and put economic growth back on track.
The Fed has spent $1.7 trillion trying to end the recession and it declared last November it would fork out another $600 million of taxpayers’ hard-earned before June.
It’s working, finally. The US is now growing again and the stock market has delivered solid gains.
But at what price? In this week – which marked the two-year anniversary of the bottom of the sharemarket in March 2009 – a raging oil price, Arab state instability, Bill Gross’s comments and the increasingly menacing spectre of inflation has investors well and truly spooked.
They have seen a ghost and it’s the ghost of a bubble.
It was loose monetary policy under former Fed chairman Alan Greenspan that led to the last collapse and rates have been kept even lower for even longer under his successor Ben Bernanke, coupled with a couple of thousand billion dollars in good old QE.
Behind Bill Gross’s decision lies not just the artificial pricing on US bonds but the trend. This big market has big trends. Get the chart up, it’s a beauty. From the mid-1950s to 1981, Treasury bonds were in a bear market. That is, the yield on the benchmark 10-year Treasury rose from less than 4 per cent to as high as 15.8 per cent in September 1981, when then-Fed chairman Paul Volcker hoisted rates to 20 per cent to vanquish inflation.
In a 27-year rally, the bond rate then fell as low as 2.05 per cent just after Christmas in 2008, the year of the financial crisis. It has bounced around since then and now hovers at about 3.4 per cent. The 30-year bond yields 4.75 per cent, not much of a rate really for lending money to the US government for 30 years.
Thanks to a recent accounting change designed to shift losses from its bond portfolio into the US Treasury – and which had no Congressional approval – the Federal Reserve’s independence is further compromised.
Unlike other central banks, the Fed is owned and controlled by a coalition of banks. Now it has been the subject, effectively, of a pre-emptive bail-out by Washington. What a deal: we stand behind you, you buy our bonds.
In any case, unless the US is headed into depression, it is a fair call that the rally in bonds is over. How high will interest rates and inflation run, and for how long? If the historical evidence is any guide, the days of low inflation are coming to a close and even though Australia’s economic fate is hitched to China these days, China depends in great degree upon the US.
When, then, will the Fed have to jam on the brakes to fight inflation? Tightening by the Chinese, coupled with poor economic data this week, helped the copper price to a shellacking. The local equities market and the $A, proxies for global growth, got hammered in the process.
As with the rest of the digital world, is it the case that economic cycles are speeding up? Just as the US is coming out of a deep recession? Surely, credit is now expanding as banks and investors hunt better returns and risk spreads contract. Even commercial property has sprung back to life.
On Bloomberg numbers, the prices of commercial properties sold by institutional investors rose 19 per cent last year. In December, commercial loans rose 8.7 per cent. Commercial mortgage-backed bond issues are slated to top $40 billion. It’s game back on.
It’s a headache for corporates making big decisions. Take Centro, for instance. If the cycle has sped up, Centro could well have picked the window to flog its US assets. If not, and this is an early stage bull market, selling to privateer Blackstone for what appears to be a bargain price, will look panicked. Regardless, the process is questionable. It’s hard to recall a $9 billion deal which was not put to shareholders for approval.
Michael West established Michael West Media in 2016 to focus on journalism of high public interest, particularly the rising power of corporations over democracy. West was formerly a journalist and editor with Fairfax newspapers, a columnist for News Corp and even, once, a stockbroker.