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Anthony Hilton: Bonds backers are blind to a bubble that risks new crash

Alan Greenspan’s post-9/11 rate cuts eventually ended in a financial crash
Alan Greenspan’s post-9/11 rate cuts eventually ended in a financial crash
17 September 2019

t is hard to see how the world is going to prevent another financial crash if the bond market carries on as it is.

The FT this month said that “about 30% of the bonds issued by governments and companies worldwide are trading at negative yields”. That means $17 trillion of outstanding debt is being paid for by creditors”.

The World Bank estimates that global GDP this year will be $88 trillion, so these bonds account for 20% of global wealth. Yet the world is paying rather than receiving interest from them.

We have almost got used to this inverted investment world — or at least some have — but it is still astonishing that the fund managers, investment consultants and pension funds still all recommend buying bonds rather than equities because “bonds are risk-free”.The only guaranteed risk is the certainty that you will lose money, which is hardly risk-free!

And that loss, when it comes, which it surely will, could set off a chain reaction that might cause another financial crash. I am indebted to Stephen Hazell-Smith writing in the SME journal Real Business for pointing this out.

Quoting the FT he comments that a variety of leading fund managers comment on the negative yields — but they seemingly are as mad as the market.

Take Rick Rieder global chief investment officer of fixed income at Black Rock. He asserts there is no bond bubble but then states that the European Central Bank should make equity investments “targeted at technology companies”.

Similarly in Japan — the state should expand its quantitative easing programme (QE) through targeted equity investments.

Then we have Bob Michele, head of global fixed income at JPMorgan Asset Management, who says again that there is no bond bubble, just the usual deployment of “central bank policies to combat declines in inflation expectations”. Moreover, the central banks “should also restart QE to counter the rising probability of global recession”.

Rick Lacaille, global chief investment officer at State Street Global Advisors, says: “This is not a bubble in the making but negative-yielding bonds are not an attractive long-term investment.” Why put investors in them, one might ask?

Finally, John Hollyer, global head of fixed income at Vanguard. He was asked for his recommendations for bonds with negative yields. His reply? “Bonds, even at low-interest rates, diversify a balanced portfolio and provide returns that differ from stocks.”

Negative bonds account for 20% of the world’s GDP. They have attracted massive amounts of money, and are still attracting even more. If that is not a bubble, then I don’t know what is. So how did we get here? The standard answer is that central banks responded to the financial crisis 11 years ago by cutting rates.

But Anthony Peters a bond trader who writes a hugely respected blog, says instead that it all started with 9/11,the attack on the World Trade Center in New York, in 2001.

He says Alan Greenspan thought that the American people could deal with a recession and they could also deal with the attacks. But they couldn’t cope with both at the same time. So he cut rates to try to avoid a downturn.

US rates had peaked at 6.5% the previous May, but had already been cut to 3.5% before the attack. But on September 17 the Fed cut again to 3% and then again in October, November and December. By 2003 they were at 1%

The flow of savings from tech to housing began in 2000 but Peters believes it was turbocharged by Alan Greenspan’s post-9/11 rate cuts in 2001. The lower rates went, the more people wanted to buy houses. The lower returns became, the more institutional investors also went in search of higher-yielding assets.

Borrowers wanted cheap money, lenders wanted high returns so the financial engineers invented ever more complex products.

They provided mortgage-backed securities packed with sub-prime assets. These were snapped up because housing never went down! Inevitably, it ended with the financial crash.

Eighteen years, one bank crisis and one massive European sovereign debt crisis later we have still learnt little. Our politics is in disarray, the world is uneasy about capitalism, people are angry and resentful, globalisation has stalled, strong men are ensconced in many countries, and America is trying to cause a trade war.

But the root of this comes from the instability caused by high debt, low rates and leverage.

And that debt is bigger today than it was in 2008.