Fixed income investors deserve some sarcasm today. Low interest rates have lulled them into thinking that bond valuations can only go up. The search for total return in the bond market is going to end with a bunch of sleepwalkers getting smacked in the face.
Central bank intervention has brought the world's fixed income markets into periods of illiquidity. Bond owners can't sell if buyers won't buy. The Fed is now considering imposing exit fees on bond funds to prevent panic selling that crashes the entire market and drives up real interest rates. I fully expect the Fed to put an instant lock-up on bond funds in a crisis, with rolling exceptions for politically connected pension funds (read: unions) that need to meet distributions immediately. Lots of retirees will wail about liquidity. Stanley Fischer is earning his pay at the Fed already.
I'm absolutely certain I'm going to get the last laugh at the expense of a whole bunch of fixed income investors. I'll LOL even harder at money managers who bought derivative bets on low yields and high valuations that they thought would last forever. I don't know if there's enough bond collateral in existence to cover those derivative bets. If not, then a whole bunch of futures contracts will be worthless as bond investors try to exit the market in a panic. The investment banks that wrote those contracts on future debt issues will be unable to make good on delivery if central banks continue to buy the lion's share of sovereign debt issuance. Some banks and insurance companies will get to relive 2008 all over again.
The buy-side investment management firms would love rules preventing sudden exits from bond funds, up to a point. The tipping point comes if high inflation degrades their bonds so much that their balance sheets are impaired and they face insolvency. Central banks and finance ministries would face a multi-faceted crisis. Should the Fed and other central banks stop buying sovereign debt, leaving inventory in the market to fill those derivatives? If so, they would have to backstop their primary dealers anyway just to ensure those investment banks have the liquidity to buy bonds that will make their derivative exposure whole. Or should the central banks buy bond holdings from the buy-side firms that may face uncontrolled liquidations? The discussion of a policy freeze is just the first consideration for financial regulators facing a global bond market at its peak.
The handwriting is on the wall and so many investors don't want to read it. Fixed income investors who start liquidating now can rotate their wealth into other assets that can still generate yield after the bond market freezes worldwide. Hard asset stocks, REITs, and ETFs await their turn at end of the global fixed income bull run. Bond fund managers can pivot to hard asset yields a lot faster than individual investors. Chair Yellen probably knows this but she can't time the exit. No one wants the secret to get out until individual investors are securely in their fixed income policy straitjackets. The average folks got handed a pile of bull once again.
Central bank intervention has brought the world's fixed income markets into periods of illiquidity. Bond owners can't sell if buyers won't buy. The Fed is now considering imposing exit fees on bond funds to prevent panic selling that crashes the entire market and drives up real interest rates. I fully expect the Fed to put an instant lock-up on bond funds in a crisis, with rolling exceptions for politically connected pension funds (read: unions) that need to meet distributions immediately. Lots of retirees will wail about liquidity. Stanley Fischer is earning his pay at the Fed already.
I'm absolutely certain I'm going to get the last laugh at the expense of a whole bunch of fixed income investors. I'll LOL even harder at money managers who bought derivative bets on low yields and high valuations that they thought would last forever. I don't know if there's enough bond collateral in existence to cover those derivative bets. If not, then a whole bunch of futures contracts will be worthless as bond investors try to exit the market in a panic. The investment banks that wrote those contracts on future debt issues will be unable to make good on delivery if central banks continue to buy the lion's share of sovereign debt issuance. Some banks and insurance companies will get to relive 2008 all over again.
The buy-side investment management firms would love rules preventing sudden exits from bond funds, up to a point. The tipping point comes if high inflation degrades their bonds so much that their balance sheets are impaired and they face insolvency. Central banks and finance ministries would face a multi-faceted crisis. Should the Fed and other central banks stop buying sovereign debt, leaving inventory in the market to fill those derivatives? If so, they would have to backstop their primary dealers anyway just to ensure those investment banks have the liquidity to buy bonds that will make their derivative exposure whole. Or should the central banks buy bond holdings from the buy-side firms that may face uncontrolled liquidations? The discussion of a policy freeze is just the first consideration for financial regulators facing a global bond market at its peak.
The handwriting is on the wall and so many investors don't want to read it. Fixed income investors who start liquidating now can rotate their wealth into other assets that can still generate yield after the bond market freezes worldwide. Hard asset stocks, REITs, and ETFs await their turn at end of the global fixed income bull run. Bond fund managers can pivot to hard asset yields a lot faster than individual investors. Chair Yellen probably knows this but she can't time the exit. No one wants the secret to get out until individual investors are securely in their fixed income policy straitjackets. The average folks got handed a pile of bull once again.
