Government bond markets are approaching their D-Day. Especially in Europe. When interest rates rise in the U.S. this week, who on God’s green Earth is going to want to be stuck holding those negative yielding bonds in northern Europe? Something’s got to give. And when it does, it might be a problem.
Some investors like Janus’ Bill Gross are warning about the possibility of a ‘1994-style’ bond market collapse. Why? Because here in the U.S., credit has shot up to $65 trillion, which is 350% of GDP. In his latest investment newsletter, Gross warns that “our highly levered system is like a truckload of nitro glycerin on a bumpy road . ” Unlike the last financial crisis, Gross argues that central banks of Europe have less flexibility, since QE programs have led to negative interest rates that have seriously hurt European life insurance and pension funds. A lot of that money has found its way into real estate, which brings up a whole other question about what will happen to that market in Europe once the European Central Bank hikes. It will happen eventually.
Last week’s ECB policy meeting is being interpreted as paving the way for an eventual exit from negative rates and QE bond purchases. ECB President Mario Draghi said at his press conference that there was no longer a “sense of urgency” about introducing further stimulus as the downside growth risk has diminished on one hand. On the other hand he also said that ECB policymakers “do not anticipate the need to lower rates further”. So, NIRP, as the acronym goes, is on its last breath.
The markets are pricing in a 68% probability that the ECB will raise the interest rate by August 2018, up from 31% last week. “Markets are likely to start bring ing forward the date of an ECB rate hike in the months ahead,” says Neil MacKinnon, an economist with VTB Capital in London.
The bond market is reacting. Inflation is rising and debt levels are high. The era of central banks buying up toxic, worthless assets with no yield…is waning.