WE WILL LOOK BACK AND WONDER
2016-06-02 8pm EDT | #bonds #inflation #Chuck Prince #China #Korea
When I tell people my theory that inflation is the next big worry, they often condescendingly nod their head. Then they kindly explain to me that, “of course they understand that no currency has ever collapsed due to deflation and that yes, they know that inflation is the ultimate end game.” They lower their voice almost to a whisper, and let me in on their little secret. “But that’s a long way off,” they reassure me. “There is no inflation to be found anywhere. You will be right, but that’s years (and maybe even decades) away…”
And maybe they are right. Maybe all of this monetary madness will forever sit on the Central Banks’ balance sheet as inert and useless as a pathetic old Hugh Hefner. But all I know is these warnings that “inflation will eventually come, but not just yet,” sound suspiciously like a Chuck Prince forecast.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” he said in an interview with the FT in Japan.
I contend we will look back at these crazy low yields and wonder what we were thinking. Ten year German bunds at 11 basis points? Thirty year JGBs at 31 bps? Fifty year Spanish paper at 2.70%? Hundred year Irish bond at 2.28%? Are you shitting me?
Just for giggles, I took the Irish 2.35s of 2116 and put a yield of 5% into the bond calculator. It’s not unreasonable to expect that sometime in the next hundred years, the yield on this bond might double. Well, what do you think happens to the price of the bond at that yield? It goes from $105 to $48. An 8% yield works out to a price of $29. Do you think the buyers are ready for this sort of decline?
If everything goes perfect, and the ECB manages to achieve their 2% inflation target over the next century, then the buyer of this bond will earn a whopping 28 basis points in real terms. And that’s if everything goes perfectly.
I know everyone is busy forecasting a massive crash to cleanse the stock bubble. Stocks might be overpriced, but they are downright cheap compared to bonds.
When Chuck Prince made his now infamous comments, few thought he was an idiot. On the contrary most commentators thought he was brilliantly taking advantage of the near ideal conditions and would prudently step to the sidelines well ahead of time.
Today I hear Chuck is long all sorts of long dated sovereign paper because he just “knows” there is another crash coming in stocks…
What’s going on in China?
I am perplexed by the conflicting signals coming out of China. One moment they are loosening, the next they are clamping down on credit. They want their currency to be stable, but at the same time they want it to reflect fundamentals.
I am becoming more concerned about the possibility of a Chinese policy error. There is too much running from one side of the boat to the other. I know they are facing a delicate rebalancing, but there seems to be an undue amount of stress.
Have a look at this chart of Korean exports to China:
The recent decline is not some simple pause. I hope the Chinese authorities are not stamping too hard on the brake.
Thanks for reading,