Tuesday, 22 May 2018

Global Yields Set to Gap Higher

Global bond yields are set to gap higher, i.e. sovereign and corporate bonds are set to sell off.  The further ramification will be a corresponding sell off in shares, and property markets.  The US 10 Year Treasury Yield, has already moved decisively above 3%, and within a short space rose to over 3.1%, though it has sunk back to around 3.08%.  Goldman Sachs were predicting a week or  so ago that it could hit 3.60% per cent by next year, but it looks like it could hit that level or at least 3.50% within a matter of a few weeks, at most.

In my predictions for 2018, I suggested that Trump would send the US economy into a rerun of the 1987 Twin deficits crisis that led to the 1987 Stock Market Crash, which until that time was the worst in history.  I pointed out that Trump was applying the same Voodoo Economics that were applied by Reagan, based on the cranky ideas of Art Laffer that if you cut taxes (particularly for the rich) you somehow magically increase the amount of taxes collected.  Those policies under Reagan showed that idea is bonkers.  It trebled the US budget deficit, and turned the US from being the world's biggest creditor country into the world's biggest debtor country.  Since I wrote that, Trump has appointed Reagan's old advisor Larry Kudlow as his economic spokesman.

I pointed out at the start of the year that the consequence of Trump's tax cuts as happened with Reagan's tax cuts, would be to reduce government revenues, fail to increase US economic growth, and would suck in imports, resulting in the trade deficit ballooning.  The US Congressional Budget Office has now confirmed that.  What there is no sign of yet, which would increase US productivity and growth is the $4 trillion infrastructure spending plans, required as a minimum to restore the crumbling US roads, rails, bridges, telecoms and so on, to the standards required of an efficient 21st Century economy.  The US is not alone in that requirement.  The implementation of conservative policies over the last 30 years and more, that concentrated on the illusion of financial wealth, meant that those conservative governments literally failed to mend the roof of their economy's infrastructure when the sun was shining, so as to minimise government borrowing, and thereby keep down interest rates, so as to keep the prices of financial assets and property inflated.  Now they have huge backlogs of expenditure to have to undertake, just like a landlord who fails to maintain their property, and then finds their lack of routine spending has undermined the fabric of the building.

The pundits on the speculation news channels have worried over the fact that yields on shorter dated bonds have been rising much faster than on longer dated bonds - yield flattening.  Traditionally, when the yield curve becomes inverted, so that longer dated yields fall below those of shorter dated bonds, it is an indication of an impending recession.  The logic being that speculators think that a recession in the near future will cause the demand for money to fall back so that interest rates fall.  In part, the current approach is based upon wishful thinking.  The financial speculators do not mind a bit of recession, if it reduces interest rates again, because those lower rates push up asset prices again.  In part, its based upon the application of a mantra rather than looking at the current reality.  The reason there is curve flattening is that shorter dated bonds are selling off as central banks have been forced to withdraw from QE - the only ones still involved are the BOJ and ECB, and they are likely to stop in the next few months - and the central banks, already way behind the curve in terms of actual market rates of interest, i.e. the rates that small businesses must pay if they can get loans, and the rates consumers have to pay for consumer credit, have started to raise their official interest rates.  That means speculators first sell these short dated securities, which are the first to get hit by the current central bank tightening.  The longer dated securities' prices simply reflect that large quantities of them are in the hands of the central banks themselves.  The fact that their prices have not fallen so much yet, is not an indication of a recession on the horizon, but simply of the fact that the central banks are not selling them!

As I also pointed out a few months ago, the reason that global interest rates are rising, is not because of inflation, but because the demand for money-capital is rising relative to the supply.  The demand for money-capital is a function of how much industrial capital needs money-capital to finance capital accumulation.  The supply is a function of how much realised profits increase, so that they are available either for direct accumulation by companies, or else are thrown by companies into money markets available for others to borrow.  It also depends upon how much of the existing stock of savings are mobilised as money capital rather than simply as money for spending purposes - including spending for the purpose of financial speculation and other forms of gambling.  If global growth rises, and companies seek to accumulate additional capital, the demand for money-capital rises.  If realised profits rise by a smaller proportion, the supply falls relative to demand, and interest rates rise.

In the last few months, we have seen the confirmation of the other point made in my predictions for 2018, which is that although global growth is continuing on a pretty synchronised basis, the usual three year cycle, would result in a relative slow down from the third quarter of 2017 to third quarter 2018.  That relative slowdown has been seen, and has slowed the rise in global interest rates.  But global growth continues at a faster pace than seen for about a decade, and it is set to rise again in the next few months.  At the same time as capital itself is expanding, and the demand for money-capital is rising, whilst tighter and tighter labour markets are starting to push up wages, and thereby, although still only tentatively, begin to squeeze profits, governments are having to increase spending on infrastructure etc. so that more government bonds are being issued, increasing their supply, and pushing down their prices, so causing yields to rise. 

As I've pointed out before, and Marx noted this process 150 years ago, as global growth is rising, and as more labour-power is employed, also at higher wages, this creates an inevitable increase in demand for wage goods.  The producers of wage goods, as a result of competition, for fear of losing market share to their rivals, then have to increase capital investment.  Interest rates are pushed higher again, and as they rise the capitalised value of financial assets begins to crash, the money flowing increasingly into real productive investment in search of profits rather than paper capital gains.

The UK, as I again pointed out at the start of the year is an anomaly.  Its economy has, and will continue to be dragged along on the coattails of this growing global economy.  But, already it can be seen that it is acting as an increasingly long tail, dragging along behind.  The UK economy, already an economy in long-term relative decline, from its 19th century heyday, was placed in even worse condition to deal with the global economy, as a result of the conservative economic policies introduced in the 1980's, and continued thereafter, to the present day.  It is itself now a bit like a 19th century aristocrat, living off its assets, and borrowing against them to fund its continued consumption.  That is another reason that conservative governments - in which I include the governments of Blair and Brown - have attempted to keep asset prices for things like shares, bonds and property massively inflated.  But, Brexit has blown that model apart far more quickly than would otherwise have been the case.  The UK has rapidly gone to the back of the pack in terms of growth, and its productivity level continues to deteriorate.  The UK economy is likely to continue to stagnate as a result of Brexit, whilst it will not be able to escape the global rise in interest rates, which will quickly burst all of those various asset price bubbles, in stocks, bonds and property.  In 1990, when interest rates rose by a much smaller percentage (as opposed to percentage points) than it is rising now, it caused house prices to fall by 40%, in a matter of a couple of months.  Conditions are more conducive to an even bigger crash today.

On top of all that is the effect of these movements on currencies, and particularly in relation to the Dollar as against emerging market economies.  I also pointed out at the start of the year that a number of inflexion points were approaching.  We have started to see the Dollar strengthening as US official rates rise, a reversal of what has been the case over the last couple years.  The US 10 Year Treasury is now the providing a positive real yield, whereas the bonds of most other G20 countries are still lower than their inflation rates.  As US rates continue to rise, the Dollar will strengthen, and EM currencies will fall, leading to them needing to raise their own official rates.  That is being seen already with Turkey.  But, the UK is also falling more and more into the category of these emerging markets, and that will increase the more it is separated from the EU.

The fall in the Pound following the Brexit vote pushed up UK inflation quickly, at the same time that it increased the slow down in the economy, creating the foundations of stagflation.  It has not been the strength of the Pound in the last six months that led to it rising against the Dollar, by around 10%, but the fall in the Dollar.  Now, as rising US official interest rates, start to exert upward pressure on the Dollar, and the impact of Brexit on the Pound, causes it to fall, that process of a weaker Pound causing higher imported inflation is likely to resume.  UK inflation is already way above the BoE's 2% target, and is likely to then start to rise again, increasing the tendency towards stagflation.  Moreover, recent reports have shown that another impact of Brexit is that the flow of migrant labour into Britain has slowed considerably, the racist hostile environment policy is also likely to have impacted that.   Its effect on labour shortages in the NHS and in social care has been well documented.  But, other recent reports show that the real problem for an industry like fishing is now the inability to recruit the required migrant labour, rather than the EU's Common Fisheries Policy.

Globally real market rates of interest have been rising for some time.  The real global economy is continuing to grow, as part of the long wave boom, and that growth looks set to pick up faster in the next few months.  Money-capital is becoming in increasing demand to finance the expansion, and the prices of financial assets have only been kept inflated as a result of a tremendous effort by central banks to keep them floating in the stratosphere.  For years, there has been no basis to own those assets as sources of revenue, because even where they were not offering nominal negative yields (which many of them continue to do), they were providing negative yields in inflation adjusted terms.  The only basis for holding them was in the expectation of large capital gains, as further speculation backed by central banks pushed their prices even further into outer space.

When speculators see the prospects of prolonged capital losses rather than gains on shares, bonds and property they will rush for the exits.  Yields on global bonds are set to gap higher, and that will be the start of the end of the current period of irrational exuberance.  For many who think that it can continue, or that current paper prices have any substance to them, it will end in tears.  But, as always happens in such crashes, for others it will be a bonanza.  Cash is King, and ironically, all those who currently had to rent, because they could not afford to buy, will find themselves in a privileged position.

No comments: