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A few weeks ago, the man formerly known as the Bond King, Bill Gross, tweeted that shorting German bunds would be the trade of the century.
I was gratified to see that he was reading my mind, as readers of my Credit Strategist newsletter already know.
As a result of a massive bond-buying program by the European Central Bank (ECB), the yields not only on German bunds but on all European debt had plunged to ridiculously low levels. Here’s what you need to know…
Europe's Negative-Yield Market Threatens Every Nation
Trillions of dollars of European debt were trading with negative yields. Speculators were front-running the ECB knowing that they could buy bonds and sell them back to ECB.
Unfortunately, things didn’t work out quite like they planned. Over the last couple of weeks, German bunds have sold off in one of the biggest bond routs in history. The yield has now spiked up to 0.65%, inflicting big losses on speculators who thought that the ECB would be able to drive yields below zero.
Now you may be asking why you should care about what happens in European bond markets. The reason is very simple – it affects what is happening in U.S. markets.
Indeed, it’s the aftershocks to the stock market that we need to fear the most…
The carnage in the European bond market is widespread.
Yields on Spanish, Italian, and French bonds have all risen by 50 basis points while Portuguese bonds have spiked by 70 basis points. Only Switzerland has seen a mere 20-basis point increase in its 10-year rates to a miniscule 0.07%.
Over the same period that German bunds fell out of bed (at one point hitting a 10-year yield low of 0.05%), the yield on 10-year U.S. Treasuries rose by 38 basis points to 2.22% (and the yield hit an intra-day high of 2.366% on May 11, its highest level in six months).
Treasuries have a strong correlation with German bunds because global investors shop around for the best place to park their money. If rates in Germany drop, it puts downward pressure on U.S. rates. It is probably no accident that 10-year rates in Japan have also spiked up to 0.45%, their highest levels in months.
But there is a bigger picture that investors need to consider.
About $2 trillion of European debt is still trading with negative yield (the actual amount changes daily). This is not only a historical anomaly but also a sign that economic policy is failing and likely to lead the world into another crisis.
Negative yields effectively confiscate capital from bondholders. The only reason to hold such a bond is because the holder believes it will trade to an even more negative yield, therefore generating a capital gain, or because the holder is required to do so to meet capital requirements or other regulatory tests.
But these negative yields are inflicting serious damage on the financial system…
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.
the global economy is now a debt casino where all stakes are debt financed at virtually zero interest rates; the punters throw ever money onto the tables and roulette because they can get ever more debt to gamble away. Losing debt means nothing now because debts are no longer repaid except with more debt.
do prices of preferred stocks go in lockstep with bonds???
what happens to the dollar?
Not to offer the slightest excuse for the execrable robbery of savers by the CBs & their cronies, but there is one market force which could result in negative interest rates: if there is a prospect of significant deflation, creditors may accept negative rates, and yet achieve a positive real return.
It's surprising that Michael didn't mention this – and indeed seems to have denied this factor in his statement about the only reasons for accepting negative-rate bonds being regulatory requirements or a (forlorn) hope for capital gain if rates get even more negative.
The ECB is force buying bonds on a partly self created bond top, and some day ECB must reverse the trade and start selling bonds, this time at a higher yield, and take an astronomic loss.
It is just one of the dummiest trades I have heard of. Loosing money for the sake of loosing money
They aren't losing money; they are buying 'Assets' with what will be worthless paper?
When the crash comes, who'll have all the Assets for the reset?
All just marking time, as we have been 'bust' for quite some time!
Great explanation of what is going on.