There is something special about events that happen for the first time ever.
When you’re a kid it’s about the first sleepover, the first team you make or the first fort you build. As you get older, it about the first kiss, first car, first job or your first child.
The same is true in markets. Historically, the most profitable events have been the ones that happened for the first time. Remember when US real estate prices stopped going up every single year for the first time? We now refer to that as The Financial Crisis. There is definitely something special about financial market “firsts.” Last week, the world experienced a milestone first and not one person anywhere has mentioned it.
As a society, we get so obsessed and focused on what happens in the US that we tend to downplay or even ignore what happens elsewhere. Even as a global macro guy who gets paid to understand the entire globe, I can be caught staring too long at the US.
It would be easy to write an entire article on last week’s grotesque jobs numbers and the market’s reaction. It would be even easier for me since the commentary would be a victory lap and filled with me saying 'I told you so' to everyone who wasn’t listening.
But you don’t read this commentary for my hubris, you read this commentary for insight. So what did the media's myopic US view miss? What historic milestone was largely overlooked last week?
For the first time ever, in the history of Earth, the amount of negative-yielding government debt surpassed $10T. That’s trillion, with a “T.”
Ten Trillion Dollars! A third of all government debt worldwide now has a negative yield. If you exclude US government debt from the equation, then 50% of global government debt yields are negative. Take a moment and let that sink in. For the first time ever, one-third of all government debt and half of all non-US government debt has negative yields. This is the type of event and the type of circumstance that really matters when it comes to evaluating markets.
It’s not Fibonacci ratios, Elliot waves, moving averages or even the much coveted Abandoned Baby Bottom Pattern. Yes, that last thing is a real thing. If you want to make a ton of money or just not lose a ton of money, then you pay attention to the events and circumstances that could have a generational impact on markets.
The level of negative yielding debt is just such an event.
How Did We Get Here?
The ECB started this party 2 years ago, and at the time people saw it as a temporary gimmick. Now here we are 2 years later, the Bank of Japan joined the party a couple of months ago and now a total of 6 central banks are rocking negative rates as part of their monetary policy. When the Bank of Japan went negative back in January, the number of bonds with negative rates doubled in 2 days! Now, 5 months later, we cross a historic $10T threshold.
The reason we hit this threshold is fairly straight forward, it’s a combination of central bank actions and institutional investor needs. Central banks around the world, most notably the ECB and the Bank of Japan, ran out of policy tricks to kick start their respective economies.
They figured if zero interest rate levels didn’t work, how about negative rates? On the institutional side, you have a global search for yield among pension funds, money managers and insurers. These institutions are buying everything not nailed down, even though if they hold negative-yielding bonds until maturity their investors will lose money.
Can you see the self-reinforcing cycle at work here? Just because yields get extremely low or go negative doesn’t reduce the need large institutional investors have for “safe” investments with a yield of any kind. Starting on June 22, the ECB itself is going to become part of this self-reinforcing cycle as it begins to buy Euro-denominated corporate bonds. This action will push yields down even further. There is already several hundred billion dollars worth of global corporate debt with a negative yield. These ECB purchases are only going to exacerbate this situation.
The truth is most of us look at our screens and we see a bond with a negative yield but we still can’t fully comprehend what the negative yield means.
Negative yields don’t exist at the consumer level. Banks aren’t offering negative mortgages or bonds with negative coupons. How would that even work?
If a bank issued a bond with a negative coupon, then every bond owner would have to pay the bank when interest was due. There is no system in place to collect all of that money. As for the negative mortgage, the bank would pay you instead of you paying the bank. There is no system to send those checks out. Essentially negative rates turn the traditional credit process into Alice in Wonderland.
I’m shocked more people aren’t discussing negative rates and their implications. The IMF came out a couple of months ago in support of negative rates. The only public dissenter so far is the Bank of Korea, who said “If economic agents accept the institution of negative interest rates as a bad signal, that the economy is shrinking or deflation is worse than expected, it may hold back economic activity.” This is pretty spot on but I have to say, if the Bank of Korea is the voice of reason in all of this madness, what does that say about the state of affairs?
Despite the fact that we are still trying to fully understand the implications of a negative interest rate world, there are a couple of things we know for certain.
First, the US now accounts for over 60% of all positive yielding government debt. The US accounts for a staggering 90% of all debt less than 1 year and 74% of all positive yielding debt with maturities between 1 and 5 years.
This means that if the Fed holds where it is or raises rates further, it’s going to force other central banks to offset the tightening conditions. Forcing yields more negative. That forces yield investors into the “safest” asset class, US Treasuries. This in turn will drive our positive yields lower and our bonds higher, especially the long-dated US Treasuries, which are currently yielding a whopping 2.51%. TLT, the ETF that tracks long-dated US Treasuries is up 11% so far this year and closed this past Friday above a critical level at $133. This self-reinforcing cycle is just getting started and is very bullish for TLT.
The second thing we know is that when you trade gold you're trading global interest rates. Gold’s worst performing periods are when interest rates are climbing or remain elevated for long periods of time.
The flipside of this is that gold performs best when yields are falling or remain low for a long period of time. If low rates are good for gold, then negative rates are great for gold.
The beauty of the LONG gold trade is that it doesn’t matter what happens in the US.Even if the Fed raises rates, this only exacerbates the self-reinforcing cycle we’ve been discussing. If the Fed stands down and maintains its current policy then the ECB and the BOJ will do enough on their own to perpetuate this craziness and the negative yields will get more negative forcing people to the US, which will push our yields lower and lower. Either way, gold is a winner.
Don’t get so caught up in the happenings in the US that you lose site of the big picture. Nothing that occurs in the US happens in a vacuum. The US cannot decouple from the rest of the world and the rest of the world looks like your 4-year old nephew’s finger painting project.
I’m not writing this commentary wearing a tin foil hat, sitting next to my cat, blogging on conspiracy sites and wondering where my Mom is with the meatloaf. I say this as a data-intensive professional investor who utilizes an investing framework specifically designed to irradiate emotion and opinion from the decision making process.
The global economy experienced a “first” last week and it’ll prove to be an epic first. The rest of the world matters too and the die has been cast. Tin foil hat, cat, conspiracy theories and Mom’s meatloaf are optional.