It’s time to talk about bubbles some more.
The other day, another widely-followed FinTwit personality decided to trot out the old “QE doesn’t really matter” line in a tweet. He even called the notion that QE inflates asset prices “a silly conspiracy theory.”
The only thing “silly” there is the idea that policymakers can dump $15 trillion at the top of the quality ladder in the process distorting the entire supply/demand dynamic and somehow not create a desperate hunt for yield that drives investors out the risk curve thereby catalyzing an ongoing compression of risk premia and a rally in financial assets of all stripes. Of course the silliest part about the idea that QE inflating asset prices is a “conspiracy theory” is the fact that central bankers the world over will tell you that they explicitly set out to create a hunt for yield. So it’s actually the exact opposite of a conspiracy – it’s official policy.
Sometimes it’s hard to determine whether these pundits are being disingenuous or whether they have simply been away from markets for so long that they no longer understand how shit works. But even if the latter is the case, you’d think that by virtue of being well-known and widely-followed, they’d have access to people who would immediately tap them on the shoulder and say something like: “hey man, just wanted to let you know that the tweet you sent out the other day about QE not mattering is patently absurd and is doing all kinds of damage to your reputation over here, so maybe it would be best if you never said anything like that again – like ever.”
Whatever the case, there is no question as to what’s going on and one glaring example of QE distortions on parade is the European credit market where a couple of months ago, € junk started trading inside of U.S. Treasury bonds.
And when you ask actual investors who are managing real money in Europe, “bubbles in credit” once again topped the list of biggest risks in BofAML’s bi-monthly credit investor survey. You’ll also note that because “quantitative failure” is a risk associated with QE, the top risk identified by European credit investors has been QE-related in nine of the last 11 surveys, interrupted only in December of 2016 and February of this year, anomalies which can be wholly attributed to “Le Pen risk” in France:
Underscoring everything said above is the following color that accompanies that chart:
The inconvenient truth about asset bubbles is that they eventually deflate…or at worst pop. December’s credit survey continues to highlight the extent to which investors are grappling with this, and the double-edged sword of monetary policy. The top risk for the next year is once again seen as bubbles in credit (26%), with Quantitative Failure (11%) having been relegated from the top spot due to improving macro in Europe. And yet, December’s survey also reveals a big jump in the number of investors worrying about themes that could clearly end the reach for yield in corporate bonds. Note 14% now say inflation is their biggest concern for the next year (up from 2% in October, and now viewed as the most underappreciated risk in ‘18), and 11% say yields rising is their chief worry.
Literally everything in there is QE -related as rising inflation would catch central banks behind the curve, forcing them to take a less gradualistic approach to normalization, an eventuality which could force an unwind of the bond trade. Here’s BofAML again:
This has become anything but normal times for Euro corporate bond investors due to the weight of ECB intervention. And, hence, what ends today’s bullish credit cycle is likely to be very different than in the past. Absent a recession, out greatest concern is an outbreak of more hawkish central banks. Why? Because we think expectations of a tangible, rather than shallow rate hiking cycle is what could ultimately break the great reach for yield trade in European corporate bonds. Note how the reach for yield in Euro credit began to kick-in when 5yr bund yields broke the 1% mark in 2011.
As far as the “fragility” bit in the first excerpted passage above goes, consider this:
Indeed, we already see evidence of rising “fragility” in Euro credit. The below charts present a “Fragility Indicator” for the Euro high-yield market. We show the percentage of the market (in % weight terms) where bond prices have experienced large standard deviation moves over the previous 6m. Understandably, fragility is high during macro shocks (such as the oil price drop in 2015). But note there has been a clear increase in big standard deviation moves in high-yield lately despite a much healthier European macro environment (and moreover, a big drop in policy uncertainty).
There you go. It’s the same story. QE effects creating distortions (read: bubbles), the idea that what breaks the spell is a policy shock possibly engendered by a quick uptick in inflation, and the notion that despite the local stability, things are more fragile.
Any questions? If so, please refer them to your favorite FinTwit pundit who will be happy to show you a chart he made on Excel that “disproves” all of the above.
