February 5 – February 11, 2016

Negative yielding government bonds. Lending to Emerging Markets hits the brakes. Japanese 10-year bond crosses the zero bound.

Three key articles that stand out this week are 1) Elaine Moore, Robin Wigglesworth, and Leo Lewis’ “Government bond yields send recession signal” in the Financial Times, 2) Jonathan Wheatley’s “Lending to emerging markets comes to halt” in the Financial Times, and 3) Richard Barley’s “Japan and the Strange Case of the Negative Bond Yields” in The Wall Street Journal.

Other items that are worth a mention:

Blackstone is considering entering the public nontraded REIT (Real Estate Investment Trust) market. No surprise considering the increased volatility in the world, lack of yield in traditional investment products, that Blackstone is probably one of the best (if not the best) suited Alternative Asset Managers with the best pedigree, and that the largest player in the market (ARC) has been brought down by an accounting scandal (only the tip of the iceberg). Watch how quickly this product category grows for Blackstone.
Bank profit margins are hurting from the declining spread between 10-year and two-year U.S. Treasuries.

From a post that Nouriel Roubini did for Project Syndicate: “…financial markets haven’t reacted very much, at least so far, to growing geopolitical risks, including those stemming from the Middle East, Europe’s identity crisis, rising tensions in Asia, and the lingering risks of a more aggressive Russia. How long can this state of affairs – in which markets not only ignore the real economy, but also discount political risk – be sustained?”

On the plus side, Voluntary Job-Quitting is up. People are feeling more confident to leave their jobs.

Interesting graphics:

From The Wall Street Journal, the Baltic Dry Index continues to fall (side note for the Hawaii readers, Matson just had its earnings call and indicated that while they’re having difficulties in its other markets – understandably considering the dramatic fall in shipping prices – things are going just swell for them in Hawaii. Thank you Jones Act.)

*Note: bold emphasis is mine, italic sections are from the articles.

Government bond yields send recession signal. Elaine Moore, Robin Wigglesworth, and Leo Lewis. Financial Times. 5 Feb. 2016.

“In Germany, the average yield on all government debt is now negative, while Japan is on course to become the first major bond market with a 10 year bond that yields nothing. In Europe and Japan, government bonds worth nearly $6tn now trade at such highs that buyers will make a loss if they hold the paper to maturity.”

So shortly thereafter, the Japanese 10 year bond did cross the zero threshold.

“At these levels the bond market is forecasting recession.” – Marcus Brookes, a fund manager at Schroders

“The Janet and John way to explain it is that for the next 10 years you have to think inflation will be much, much lower than 2% to want to buy these bonds. Otherwise you’d be locking in a loss.” – Brookes

“Investors face the difficult prospect of assessing whether low inflation has become ingrained thanks to the collapse in commodity prices. A greater concern: has central bank interference in the financial markets made pricing so opaque that investors are risking the sort of losses incurred last April, when a European Central Bank driven rally in bond markets suddenly expired?”

“The lifespan of the rally in government bonds will depend on how long investors keep faith in central banks, says Tad Rivelle, chief investment officer for fixed income at TCW, a Los Angeles based asset manager. Every economic cycle has a grand narrative that eventually unravels, he says. In the late 1990s it was the information revolution, in the 2000s it was housing prices.

‘This cycle the narrative has been that central banks have got the ball, know what they’re doing and can keep the game going as long as they want,’ he says. ‘But humans have not found a way to abolish cycles.'”

Lending to emerging markets comes to halt. Jonathan Wheatley. Financial Times. 5 Feb. 2016.

More good news.

“The surge in lending to emerging markets that helped fuel their own – and much of the world’s – growth over the past 15 years has come to a halt, and may now give way to a “vicious circle” of deleveraging, financial market turmoil and a global economic downturn, the Bank for International Settlements has warned.”

“That reversal has already taken place, according to BIS data released on Friday.

The total stock of dollar-denominated credit in bonds and bank loans to emerging markets – including that to governments, companies and households but excluding that to banks – was $3.33tn at the end of September 2015, down from $3.36tn at the end of June.

It marks the first decline in such lending since the first quarter of 2009, during the global financial crisis, according to the BIS.“

“The Institute of International Finance, an industry body, said last month that emerging markets has seen net capital outflows of an estimated $735bn during 2015, the first year of net outflows since 1988.“

Hyun Song Shin, head of research at the BIS, noted that “while some advanced economies had reduced leverage after the crisis, debt had continued to build up in many emerging economies. ‘Recent events are manifestations of maturing financial cycles in some emerging economies.'”

Shin “noted that the indebtedness of companies in emerging markets as a percentage of GDP had overtaken that of those in developed markets in 2013, just as the profitability of EM companies had fallen below that of DM ones for the first time.”

“Now that the dollar is strengthening, we have turned into a deleveraging cycle in Ems. So there is a sudden surge in measurable risk; all the weaknesses are suddenly being uncovered.“

Japan and the Strange Case of the Negative Bond Yields. Richard Barley. The Wall Street Journal. 9 Feb. 2016.

“Japanese 10-year government bond yields turned negative for the first time ever Tuesday, and now stand at minus 0.03%. The feat has already been recorded elsewhere – the Swiss 10-year bond yields minus 0.4% – but this is the first time a member of the Group of Seven economies has seen such a development.”

“The JGB (Japanese Government Bond) market has for many over the years looked like an accident waiting to happen. The country’s debt stands at a staggering 2.4 times gross domestic product, a level far above its peers, and still rising. The International Monetary Fund thinks the ratio could reach 2.9 times by 2030. Japan lost its triple-A rating from Moody’s as long ago as 1998; it currently stands at A1.”

“Across global fixed-income markets, there are now $8.7 trillion of bonds sporting a negative yield, or 21.1% of the total outstanding, according to Bank of America Merrill Lynch data.”

And yet the Yen keeps getting stronger…. To help understand Why the Yen Just Keeps Getting Stronger, see Alex Frangos’ article in The Wall Street Journal.

Other Interesting Articles

Bloomberg Businessweek

The Economist