When policies kill an asset class – and more – in the process

If holding safe assets – whether money-market balances or high-grade bonds – is starting to feel like brain surgery without anesthesia, well that’s because it is. Blame it on the Fed and global central banks. In the US, cash rates are 0% and for some time now the entire Treasury inflation-linked curve is yielding below that as well. To be clear: all US TIPS are priced to make you lose money, after inflation.

How did we get here and why? Initially for sheer economic and systemic necessity. Then, having been drugged by the elixir of no interest, we were pushed further along the cliff by the surprisingly swift acceptance of academically-credentialled new monetary ‘theories.’ Finally, to boot, a mentally imbalanced president bullied Fed officials into action even before COVID-19 wreaked havoc on the world. What a difference 12 years can make.

People responded to these conditions in one of two ways: by shrugging and leaving portfolio risk and exposures relatively unchanged, or by tilting portfolios towards levels of risk which were not compatible with their investment horizon. As I wrote some time ago in this post, most people would appear to have selected the latter option. This move was further encouraged by commentaries from experts highlighting the lack of alternatives, the ‘reasonable’ valuation levels, the death of inflation and other superficially appealing ideas.

What we have witnessed in the process is the methodical elimination of an asset class, helped by ostensibly populist policies with consequences which I’m sure no one really has taken the time to think through. Bonds’ natural characteristics have been disfigured to such an extent that they have lost much of their usefulness – either for income generation or for risk balancing purposes. Somewhat circuitously, they have become equity vehicles in disguise: their cheapness (from the point of view of the debt issuer or borrower) has encouraged enormous issuance of debt, especially corporate, the risk of which is ultimately borne by the very purchasers of equities.

One thing the proponents of these policies don’t realize – or they realize but could not care less – is that they tend to hurt the people who need the income and safety of bonds the most. And by doing so they reveal themselves for what they really are – namely, policies for the despised elites.

There is no hope of having a civilized or engaging discourse on any of this today. Between legitimate global concerns (like the coronavirus challenge) and a political backdrop which can only be described as suicidal, I for one have no expectation of any brilliant solution.

May the idiocy and mindless polarization that have so far prevailed around the policy of ‘wearing of face masks’ not be repeated in dealing with the ‘death of bonds.’

May cooler heads – wherever they might be – take charge of a pragmatic process that can get us out of this bind.

Roberto Plaja, July 16, 2020

Cover: Jan Sanders van Hemessen, ‘The Surgeon’, c. 1550-1555