English Gold Has Been Our Bane

Mint – Blain’s Morning Porridge  - February 19 2014

But English Gold has been our bane – such a parcel of rogues in a Nation…

Where are we in terms of market direction? We’ve already seen last quarter’s growth enthusiasm quickly tempered by the comprehensive January correction on weaker than expected economic signals. But the last two weeks of subsequent recovery in stocks has been pretty convincing – suggesting that fears of renewed global slowdown were overplayed.

Yet we also have a fairly bullish treasury market – with many large funds like PIMCO at pretty much record levels invested in US govies. On the basis of bond market rule 1 – “markets will always seek to inflict the maximum amount of pain on the maximum number of participants”, I suspect we remain in a large amplitude wave-form market for a while until the economics become clearer, at which point the conditions of maximum pain will be suddenly felt.

What’s really happening? If we knew the answer to that… well I wouldn’t be writing the porridge each morning. The diversity of views is well illustrated by a great article on Bloomberg on the treasury market this morning: the dealers and investors who say further gains in bonds must be limited, versus those who see real evidence of a “deceleration” in growth with weaker growth, limited inflation and lower yields for the longer term.

Some quotes worth highlighting:

“No one should be buying into these levels…treasuries don’t offer a good margin of safety right now…”

“The window for bond rises is limited...this time is a buying opportunity for risk assets.”

“The [bond] rally is an overreaction.. we’ve more than priced in the economic weakness we’ve seen.”

Other blogs this morning talk about yield compression in higher yielding sectors as money chases any form of enhanced return. If there is demand for “risk-on” assets, it’s hardly a surprise the new issue sausage machine is gearing up. Sure enough, I glimpsed something in the FT about record Spanish corporate issuance.

The fact UK inflation now looks on trend to continue falling, giving respite to the MPC being forced towards an early rate hike, is a good illustration of where rate expectations are going. Markets are no longer anticipating imminent hikes. They are getting less vigilant. Oops.

Talking to accounts here from London about other asset classes we’re hearing a similar diversity of views. Some that think the prospects for further tightening from corporates to high yield represent an absolute buying window. Others point out “one man’s buy-window is another man’s selling opportunity”.

Now I appreciate none of that helps – at best the ramble above is balanced in terms of: maybe bonds rally, maybe they decline, maybe they stay range-bound. But what if we have a game changer? What if the economic picture fundamentally changes? Could we face another reversal in bonds? We are thinking about positive stock reads on the policy meetings this week in Mexico (NAFTO), Sydney (G20) and Singapore (PTT) – agreement on enhanced global trade could further boost growth expectations. Stocks up 5% in the next five days?

But what about bonds? Is there an imminent sell-off danger? Inflation threats are limited. Economic growth remains conceptual rather than factual – i.e. a boost to growth is expected rather than happening! Perhaps a little bit of a risk-on move out of safe havens? There is no real reason to expect a real sell-off yet. But neither is there much reason to expect much of a rally – unless we see further signals global growth is off the agenda.

Which leads us to China – and Robert Peston hit all the obvious spots in his “How China Fooled the World” programme last night. Part travelogue, part imminent banking crisis thriller… It was a decent primer for anyone wanting the skinny on China, and balanced. I suppose he was unlikely to lambast the Wuhan major who ignored his pointed questions about the real scale of the regional debt. Scary hair lady Charlene Chu (the ex-Fitch China uber-bear maven)'s comments about unfettered banking boom were balanced with plenty of “don’t write off China cos you don’t understand it” comments. George Magnus did a nice line in.. “well it's not 2007 for China.. more like 2005/6.” I’d recommend an hour spent with the iPlayer if you were watching Manchester City lose to Barcelona last night would be time well spent.  

But after my comments yesterday on the risks of a possible Abegeddon and a China implosion on global growth expectations, I also got an email from a contact in China this morning: he is very bearish on Japan, and comments “the collapse of the Japanese illusion bubble would have a significance well beyond the present concerns China might grow at 5% rather than 7%!”.   I get the point.. China may have ructions coming.. but they will cope.

Stop Press… Hot news from North Britain

Danny Alexander (UK Treasury chap) has rather cleverly announced Scotland is free to issue its own debt. Nice touch. Would you buy a UK gilt or a Scottish thistle bond? Sure, you will buy the thistle….. if its higher yield over gilts compensates for how much less liquid it will be than a gilt, and the possibility Scotland ends up an independent state run by Alex Salmond. What would your risk-reward demand be? 50 basis points? 100 bps? 1000 bps?

It’s a very unsubtle way to demonstrate to Scottish voters how much more it will cost Scotland to borrow as an independent state. A lot is the answer.

Mind you.. since running Scotland’s debt office is the job I crave…. I’m kinda disappointed Danny’s not been on the phone offering me the job. I could do it part time… from here in Mint Towers, since it’s highly unlikely a thistle bond will ever be launched…

Bill Blain

0207 786 3877

[email protected]

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