KingBond,globalmoneysupplychainandNFPrelease

In our notes we keep writing that of all the asset classes in the world if one has to coronate one as a king, it would be the bond market. Readers would remember that in past we invoked a famous quip by Bill Clinton’s political strategist James Carville that in case “he has a reincarnation he would like to become not Pope or the president but would like to come back as the bond market”. Carville’s pithy insight from three decades back remains highly relevant even now and sums up squarely where the reins of power lie. It is neither with the church nor the elected king but with the credit markets.

Readers would do well to take a moment and internalise Carville’s insight. The prices in all other markets eventually emanate from the prices set in the bond markets. The equity prices depend on the discount rates at which the future cash flows will be pv’ed. As the denominator declines the resultant goes up. The differential in the bond yields set up the carry trade which makes the money flow around the world. The smart money chases the yield pick up across the world and in the process ends up tying far flung economies together in a global value thread. Sometimes the calls go haywire as the credit risk bites but even in those cases the run to exit is ultra-immediate. Then there are multiple strategies within the bond universe itself, like the one where bets are on the differential between on the run and off the run securities. Roger Lowenstein in his book When Genius Failed described the pitfalls of such strategy in the context of a highly leveraged and highly celebrated hedge fund whose demise once threatened the survival of the entire market.

Having prepared the ground let’s see how the global bond yields are faring today. We will discuss about the 10-year benchmark bonds for simplicity sake. The US 10-year bond trades at 1.58, German at -0.23 (negative 23 bps), Italian bond at 0.85, Russian at 7.08, India at 5.97 and Greek bond at 0.98. The interesting facts which can be added to this table is that in 2011 the Greek bond yield was close to 40%. So, from 40% to 1% in a decade. Similarly, the hedge fund which we mentioned in the previous paragraph met its demise when the Russian government defaulted on its bonds in 1997. The Italian bond which is yielding 85 bps now was part of the infamous PIGS club not so long back. The readers would be knowing that moving between the German, Italian and Greek bonds the investors don’t take any currency risk, they are all denominated in the Euro. Moving from German to Russian however involves the Euro Ruble exchange rate risk.

Now tie all this up. Demand for bonds is getting manufactured on a monthly basis. US Fed is buying 120 bn USD worth of bonds, ECB is buying 80 bn worth of Euro under PEPP, BOE , BOJ etc are also doing their bit. The way this supply chain works is the fresh money creation depresses the yield in one country, then the flows start permeating across the borders, impacting yields in other places. Drop in yield on safer assets (read government, AAA bonds) then prods the investor to look elsewhere prompting a price increase in other asset classes. That’s why we track keenly how the yield trajectory in places like the US and Europe (rest everything else is more a derivative of it). Hence when Powell says that even if the US economy is looking good any taper in purchase is way off or Lagarde says that PEPP will continue even beyond the 2022, it brings a cheer across the world and adds to global “risk on” sentiment.

We will have the NFP data coming out tomorrow. Post Yellen’s retraction of her statements yesterday on the rise in interest rates we remain confident that even a highly positive number won’t bother the markets. If anything, it will add to the charm of equities as the goldilocks argument will be offered. High growth, low inflation, can anything be better than this.  Domestically the RBI’s Governor address yesterday was about announcing some adjustment measures and targeted relief for fighting the virus.  The bond yields remained subdued post the announcement.