According to research firm Coalition, as cited in the Financial Times, the top 12 investment banks in the world saw revenues drop by 15% in the first half of the year! Obviously a part of this decline is due to new regulations and capital requirements. Although the banks have arguably become less important, clearly they are still a large part of the transmission mechanism for monetary policy. Central bank policies are hurting banks, not helping. The only conclusion that can be drawn is that banks can’t find productive uses for zero pct funding. How about the corporate sector? In the US, as has been well documented, companies are issuing debt to buy back shares and support dividends rather than investing in productive capital expenditures. According to the Fed’s latest Z.1 report, Corporate Debt in Q1 2016 rose at an 8.9% annual rate. From Q1 2014 to Q1 2016 the amount of Corporate Debt Outstanding rose $1Trillion from 7.28T to 8.28T. Part of the theoretical underpinning for Quantitative Easing and rates near zero is that various economic players would increase risk tolerance and light a speculative fire under the economy. Risk tolerance has increased – for financial assets – as long as Central Bank support is hovering in the background.
The point is that globally, central bank are coming under attack. There has been a shift to the idea of fiscal infrastructure spending as a more powerful tool for spurring economic activity.
Note that the Bank of Japan has been one of the most aggressive proponents of quantitative easing and zero rates. The heavy handedness of the monetary authorities there has made the market much more vulnerable to any suggestion that support might change. Indeed, the Japanese Ten Year yield has soared since the end of July, from -29.5 bps to -2.3, a bit over ¼%. (This move erased the yield decline of the previous four months). In the US we actually saw a similar move, from 1.36% in early July to a high of 1.63% in late August. The shift away from dependence on monetary policies, along with a new emphasis toward targeted fiscal policies, may slowly be changing the psychology of bond markets.
These changes can be subtle in the beginning, and then accelerate. For example, the current yield chart of the US Ten Year treasury looks very similar to the low in rates made in 2012. That low, of 1.39% occurred in July of 2012, but it wasn’t for another ten months that rates really exploded in May of 2013, as the Temper Tantrum sparked a move to 3% late in the 3rd quarter. In July of this year, the ten year made almost the exact same low of 1.36%. It has since been grinding higher. I have no specific trade recommendation besides this: Avoid being long fixed income, especially longer duration instruments. The tide of risk/reward has changed.
Alex Manzara
