So far, 2020 has been defined by a pair of “big market themes” that keep “marching on”, BofA’s Michael Hartnett said this week.
Those two themes: “Great Repression” and “Great Debasement”.
They are, of course, interrelated. The latter is generally credited with pushing spot gold prices through $1,900, as investors ponder a brave new world characterized by fiscal-monetary “partnerships”, wherein central banks openly and explicitly enable government spending.
That government spending “should” lead to inflation, but thanks to the “Great Repression”, investors can’t hedge that with a short bond position.
You wouldn’t step in front of a Mack Truck, and by the same logic, you don’t generally want to bet against central banks when they’re determined to keep a lid on yields.
As discussed at length in “The Guarantee (No Country For Old Bond Vigilantes)“, yields become little more than policy variables in the face of a credible commitment by a respected monetary authority. For example, the figure (below) shows the Australian three-year rate following the introduction of yield-curve control by the RBA in March.
Ideally, the market will get the message and give up, obviating the need for the central bank to defend whatever level it’s targeting. Hence the “beauty” of yield-curve control. Theoretically, you could end up buying fewer bonds if you’re the central bank, thus leaving you with more ammunition should you need it.
So, if the market can’t short bonds to hedge the presumed inflationary impact of massive budget deficits, traders turn to gold or, in the case of the situation in the US (where a perfect storm of factors is conspiring against the greenback) you short the dollar.
Asset purchases of nearly $8 trillion are indicative of the “Great Repression”, and as BofA’s Hartnett writes, those purchases have “crushed interest rates, corporate bond spreads, volatility and bears”.
Signs of the “Great Repression” are everywhere. 10-year yields in Italy and Greece are back to 1%, for instance.
The Fed’s backstop has driven yields on IG US corporate credit to record lows and mortgage rates have plunged to around 3%, to cite a couple of additional examples.
But, for BofA’s Hartnett, the most “perfect” manifestation of financial repression can be found in the juxtaposition between exploding deficits and moribund rates vol.
US rates, you’re reminded, are stuck in the summer doldrums, content to ply a hapless range, with 10s, 2s, and, by extension, the 2s10s, moving sideways in what I’ve generally described as a “listless drift” and “a raft in calm waters”.
With that in mind, I’ll present the following from Hartnett without further comment, other than to say that the visual in the left pane appears to rely on some extrapolation, so safest to simply deliver it “as is”, so to speak. To wit:
Most perfect example of repression: US fiscal deficit jumped from 7% to 40% of GDP in Q2’20 (Chart 3)…less than one month later volatility of US Treasury market fell close to all-time low (Chart 4).