The recent volatility in equity markets and the rush for bonds has once again created many disconnects in asset prices. Over 55% of the equities in the S&P 500 now yield more than the ten-year US treasury. The whole of the German yield curve is in negative territory. Why the German Bundesbank does not issue debt and buy equities as the Japanese government have been doing is a mystery? The ECB bought corporate debt during their bond purchase program, that is one small step away from equities. The US yield curve flattened once again, reflecting more significant concerns of a US recession.
China’s central bank stepped in and calmed nerves as Wall Street fell sharply on Wednesday in early trading. Supporting the yuan back above 7 to the USD. Equity market sentiment, as we speculated earlier this week, is now at the mercy of the Chinese currency.
The debate as to what the Fed should do in the light of the latest developments. The idea of a “mid-cycle adjustment” as Jerome Powell put it, may not be sufficient to maintain the economic expansion the Fed target. There is already in the World approximately 13 trillion dollars of negatively yielding debt. Comments from the World’s largest actively managed bond fund, Pimco, indicate they believe that US treasuries could add to that list.
From a central banker to a politician, a professional or retail investor, we continue to try and navigate through a world economy, the legacy of which is the financial crisis of 2008. The World remains largely indebted; low-interest rates are required to finance the debt and to continue to support the global economy. The Federal Reserve tried its best to normalise interest rates to some degree during a period when fiscal policy helped support the economy. They may have to reverse that decision in the coming year. Imagining a world where interest rates where what was considered normal 15 years ago, would be imaging an economic collapse. For these reasons, this has been one of the most unloved equity rises in history and remains mostly so. The Japanese economy has functioned since the mid-’90s with zero or near-zero interest rates and continues to do so. Perhaps the rest of the world can? The youth of today have known little else.