Baccardax: Bonds Are Still a Screaming Buy
" … yeah, I buy. Take it and bid it!"
Sharp-eyed readers (or those of a certain age) will recognize the line from Oliver Stone's cameo appearance in his Oscar-winning film "Wall Street". In that brief role, Stone was hopping on the bandwagon of shares in a fictional takeover target, Anacot Steel.
If Stone's character – or indeed Gordon Gekko himself – were around today, they'd be saying much the same thing, but not about any "in-play" stock. They'd be talking about bonds.
Longer-dated bonds across the globe are cheaper this week than they were last week (34 basis points for 10-year Gilts, 34 bps for Bunds, 31 bps for Treasurys) as investors fret about the increasing credit risk facing several issuers and juggle portfolios to accommodate the record amount of supply that will be sold this year.
But the recent lull in the government bond market's bullish tone only enhances the arguments for ramping-up a portfolio of the heretofore dullards of the financial markets.
Inflation, the "enemy" of bonds (as it erodes the vale of future payments) is slowing rapidly around the world, kicking away the final plank supporting central bank arguments against interest rate cuts (especially in Europe and the United Kingdom). Capital preservation remains paramount, risk aversion extreme and liquidity essential. Bonds tick all these boxes with ease, even in a world where triple-A credit ratings are at risk.
Look at this way: there's no reason whatsoever for a nation to default on its domestic currency debt. None. They can simply print more currency and pay the coupons. Yes, value is eroded on an exchange-rate basis, but that's only in the extremis. Besides - quantitative easing from central banks will bid back any at-risk debt long before that becomes a concern.
Supply is another oft-cited concern – and it's clearly linked to sovereign credit risk – but it's one we can probably put to be pretty easily. Apart from Japan, which has a debt-to-GDP ratio of 190 percent, most G-7 borrowers can add a further five to 10 percent of GDP to finance stimulus programs and still maintain triple-A status, according to Carl Weinberg at High Frequency Economics.
Add to that the fact that even if governments have turned on the stimulative spending tap, the cash has mostly been sucked up in the swamp of bank de-leveraging and asset price deflation. Unless that swap is run dry – and there are at present few signs of that happening any time soon – the multiplying effect of government spending simply can't create inflationary pressures.
Okay, you say. But who's going to buy the $2 trillion in US Treasurys likely to hit the market this year, not to mention the 146 billion pounds in Gilts and the several billion in Eurozone government debt after pension funds, asset managers, retail investors and (the few remaining) hedge funds push back from table and say "basta"?
China, that's who.
Skeptical? Don't be. China's economy is slowing, and slowing fast. Its exports are collapsing, even as its trade surplus increases, suggesting the next Treasury Secretary's concerns about currency manipulation are well-founded.
But for bonds buyers – that's a good thing! If China can't stoke domestic demand, it's going to need to export its way out of sub-five percent GDP growth. That's going to require cheap goods, a weak yuan … and lots of Treasury, Gilt and Bund purchases along the way.
Take it and bid it, indeed.