I have decided to start writing a daily post without any sort of formal thematic objective. I used to do this years ago, before I started working on TV and my workload there made me pull back from the website. But I don’t think I’ve posted anything like that for a couple of years now. It started as links to interesting websites and morphed into sort of a catch-all commentary. As I bring the daily post back, I’m not sure what form it will eventually take. Let’s just see where this leads us.
But here’s the topic that I have top of mind: the selloff in bonds. The position I have been stressing is one that is counter to the bond bear market narrative. However, this is a longer-term view that stems from the challenges I see to global growth due to income stagnation in the middle classes of the developed economies. Over the shorter-term, there is a reason to be optimistic about the global economy. And that means interest rates will rise. The real question is about the transition to the longer-term.
It’s what’s going on with Bunds that triggered my desire to write this post. Yesterday Holger Zschaepitz tweeted a chart showing Bunds and Treasuries at their highest yields in 3 to 4 years.
The selloff in global bonds continues. 10y German Bunds yields hit highest since 2015, 10y US Treasuries yields highest since 2014. pic.twitter.com/BoediVz3W2
— Holger Zschaepitz (@Schuldensuehner)
Yesterday morning, I also retweeted the Financial Times on the selloff in German Bunds.
German 5-year yield turns positive for first time since 2015 https://t.co/f37QgLuPo8
— Financial Times (@FT)
…and Bloomberg on Treasuries…
— Bloomberg Markets (@markets)
The selloff in Europe is the one I find interesting because it is anticipatory. The dollar is falling, despite rising US base rates, even while other central banks are committed to quantitative easing. But the European economy is doing the best it’s done in a decade. And so it makes sense to see the euro rise if you think the ECB will withdraw accommodation and become more hawkish.
The same is true about European yields. Italy auctioned off 10-year BTPs this morning at a yield of 2.06%. The previous auction was 20 basis points further in at 1.86%. I think this is where the rubber hits the road for the bond bear. How high can yields realistically go for BTPs before it becomes painful for Italy? Remember, they aren’t a currency issuing nation. The euro is effectively a foreign currency for them. And growth in Italy is still poor, while the government debt load is high.
My sense is that the bond selloff has a cap on it before it becomes problematic. I don’t know where that cap is. But the situation in Italy shows you one place to look for why we have to be cautious when thinking about a bond bear market.
Another theme that I think counters the longer-term bond bear thinking is the loss of wage acceleration in the developed economies. Take a look at this tweet and chart on wage growth.
Japanese median wages have fallen a lot in the past 30 years pic.twitter.com/ogV0QJyvAb
— ((David Shor)) (@davidshor)
I retweeted it with the comment: “Huge gap between Japanese productivity and wages from about 1998 on, approx. same period as deflation.” What I was thinking is that it was interesting to see that Japanese wages stalled at exactly the same point I believe deflation became a real issue. I’m going to check that right now. Yes, here is a chart from Trading Economics on Japanese inflation. And it shows inflation trending toward deflation after the Bubble Economy collapse. Then it kicks up pre-Kobe earthquake before collapsing around 1998 — semi-permanently, with two blips in 2008 and 2014.
My working hypothesis here is that wage stagnation in Japan was a large contributing factor to low nominal growth rates and deflation. And this in turn caused nominal interest rates to plummet as well. If this is true, the question becomes why Japanese wages fell. They didn’t just stagnate, they fell. And judging from the chart above, we are seeing stagnation of wages in other developed economies that could hold back domestic consumption growth as well.
All of this is meant to say that I think that poor wage growth is endemic in developed economies because of globalization and global wage arbitrage. There are workers in Romania that can do the same work as Germans – and they are just as well-educated. Indian IT workers can do the same work Americans can do and they are also just as well-educated. China and Mexico can host manufacturing facilities with local workers, whose output is just as good as American or Canadian workers. How do developed economies deal with this?
Domestic growth in the operating economic paradigm is fuelled by consumption, that is in turn fuelled by wages and debt. Without wage growth and debt growth, countries must ‘beggar thy neighbour’ and export their products and services to maintain growth. Not everyone can do that. The Swiss can do it, the Germans can do it, the Dutch can do it, and the Chinese can do it. But some nation has to be a net importer for that to work. And those net importing nations, if they have the same constraints regarding debt and wage growth, will only be able to absorb so many imports before growth begins to wane.
So that’s where I come out then — over the short-term, synchronized global growth will work against bonds. But over the longer-term, a host of factors act as a cap on inflation that will work in bonds’ favour. I am not convinced yet that we have seen the end of the secular bond bull market.
That’s it for today.
One note though — keep your eye on rising delinquencies in buoyant markets. I saw on Sunday that Tracy Alloway was tweeting about subprime auto losses increasing while spreads were tightening.
Losses on subprime auto bonds are picking up so obviously spreads are tightening. pic.twitter.com/6xyipNmjLi
— Tracy Alloway (@tracyalloway)
This could just be a blip. But if it is a trend that continues, it has the hallmarks of the end of the credit cycle for subprime auto.
P.S. – It’s February 1 now. See an update to this post that I just wrote based on commentary by Alan Greenspan here.