1.Stock Bubble? $8 Trillion in Bonds Outstanding have Negative Interest Rates.
Torsten Slok
Sometimes clients ask me “Where is the bubble in financial markets?”. I think the answer to that question is easy: It is the red area in the chart below. $8trn in global debt is trading at negative interest rates. Think about it; almost a decade after the financial crisis we still have $8trn in bonds which yield negative returns.
It is the unattractiveness of these bonds for investors which is the biggest bubble in markets today. These $8trn in negative yielding assets have forced investors around the world into all kinds of other asset classes such as IG credit, loans, mortgages, HY bonds, equities, and even emerging markets fixed income and equities.
The Fed running down their balance sheet by a 50 billion here and $50 billion there is not going to make a difference to this chart. The real test will be when the red area in the chart below turns black. When these $8trn suddenly begin to yield a positive return how are global investors going to react? The fear is that when the risk-free interest rate goes higher then credit spreads will widen and equities underperform as investors leave risky assets and come home to higher-yielding government bonds. In finance terms, if the risk-free rate goes higher why should I then be buying risky assets?
When will this bubble burst? It will happen the day we begin to see inflation in the US. Because higher US inflation will mean more and faster rate hikes from the Fed, which will mean higher rates globally, including in Europe and also Japan. The good news is that consensus doesn’t expect US core inflation to move higher until 2018Q2. The bad news is that the $8trn in the chart below shows that investors don’t believe we will ever see inflation again. The bottom line is that the central bank exit has barely started and once inflation does start to move higher then checking out from Hotel Easy Money will be a lot more difficult than checking in.
Torsten Sløk, Ph.D.
Tel: 212 250 2155
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