“It’s the end of the world as we know it, and I feel fine.” – R.E.M.
Michael Stipe sang those lyrics 31 years ago on the iconic album Document. This week they seem to be coming true in the bond market.
“The world as we know it” is quantitative easing: ultra low interest rates intended to ease the pain of financial bubbles bursting. The policy usually involved central bankers buying bonds to inject cash into the financial system. Higher prices for bonds, don’t forget, means lower yields and lower interest rates. This regime has been the status quo around the world for years, but current events suggest a major sea change is underway.
The first tremor hit on Tuesday when the Bank of Japan surprised traders by reducing its bond purchases.1 That’s a big deal in a country that invented “QE” more a decade ago. Will the land of the Rising Sun become the land of rising interest rates?
The next headline appeared the following day when “bond guru” Bill Gross declared that a multi-decade influx of money into Treasuries had come to an end.2 Gross at one point ran the world’s largest fixed-income fund at Pimco.
Minutes from the European Central Bank’s December meeting provided the third big splash this morning. “The language pertaining to various dimensions of the monetary policy stance and forward guidance could be revisited early in the coming year.”3 In other words, QE is on the way out.
It’s hard to overemphasize the importance of these events because interest rates have been on the decline since the early 1980s. An entire generation of investors have grown accustomed to it — some might even say “complacent.” That prompted another famous money manager, Bill Miller, to predict another 30% upside in the S&P 500 as trillions of dollars flee bonds in favor of equities.4
Wait a sec, that sounds like a “forced liquidation.” Isn’t that scary? Well, yes and no. Forced liquidations are dangerous when a crisis forces investors to unwind risky positions like mortgages or stocks. But this time, it’s the safe havens that are getting dumped: First of all bonds. But also Utilities, Real-Estate Investment Trusts and Consumer Staples. To top it off, the World Bank raised its global growth forecast yesterday.5 And, another prominent financier, JPMorgan CEO Jamie Dimon, said his own economists are too pessimistic about conditions in the U.S.6 (All these headlines, and it’s only Thursday.) Meanwhile, “risk-on” sectors like energy, industrials, and materials, are surging.
Bottom line: It’s the end of the world as investors have known it, but the market feels fine.
1. Reuters: Japan’s central bank trims bond purchases, prompting taper talk. 1/9/18.
2. CNBC: Bond guru Bill Gross signals a new era for Treasury markets. 1/10/18.
3. European Central Bank: Account of the monetary policy meeting. 1/11/18.
4. CNBC: Legendary investor Bill Miller: Market could be headed for a ‘melt-up’ of 30%. 1/11/18.
5. RTTNews: World Bank Raises Global Growth Projections. 1/10/18.
6. Marketwatch: Dimon thinks even his own economist at J.P. Morgan is dead wrong about GDP, predicts 4% U.S. growth. 1/10/18.