How Much Repricing Is Allowed?

Germany is poised to authorize billions in additional debt-funded virus relief spending, sources said Monday.

The money, should it be needed, would go towards “tests and other measures,” Bloomberg reported, adding that the Finance Ministry will likely call for the suspension of the country’s infamous constitutional debt brake for a third consecutive year in 2022.

It’s tragic that it took a pandemic to snap the developed world out of the deficit dogma trap. The idea of sacrificing jobs, livelihoods, and actual lives at the alter of imaginary budget constraints is pure, unadulterated insanity, especially when borrowing costs are negative. “Despite [a 27bps] increase in yields, bunds are still trading richer than they ought to be by at least 15bps,” Bloomberg’s Ven Ram remarked on Monday.

Why bring this up? Well, because it plays into the narrative driving the global bond selloff. More debt, more spending, and less “discipline,” should entail higher yields although, again, “higher” is about as relative a term as relative terms get when you’re talking about the German yield curve.

Nomura’s Charlie McElligott mentioned the linked Bloomberg piece (above) in a note Monday, before adding some color that helped contextualize the burgeoning bond rout.

“As Bonds continue to reprice, you’ll increasingly incentivize forced/structural buyers of fixed-income back into the pool,” he said, citing domestic bank buyers, pension rebalancers and FX-hedged foreign buyers.

In addition, it’s important (and that’s an amusing understatement) to keep in mind that the Fed has explicitly committed to keeping rates in check. That doesn’t mean they won’t tolerate a benign backup at the long-end, especially if it’s seen as helpful for banks or indicative of growth expectations or [fill in the blank with your favorite spin]. But “benign” is the key word there.

The chances of Jerome Powell sitting on his hands and allowing yields to spiral higher, tightening financial conditions and pushing up borrowing costs are slim indeed. He’s already “guilty by association” vis-à-vis the Q4 2018 mini-bear market, and I seriously doubt he wants his name attached to “Taper Tantrum: Part Deux.”

“Every acceleration of [the] selloff perversely moves us closer to the Fed ‘dovish’ jawboning in order to maintain control of financial conditions and avoid ‘tantrums,'” Nomura’s McElligott went on to say Monday, while cautioning that, in the near-term anyway, we may be witnessing “a buyers’ strike, as participants continue to watch the market ‘come to them’ and cheapen in their favor, in turn rewarding their patience.”

That kind of mentality could be self-fulfilling (i.e., “Bonds keep getting cheaper, maybe if I just wait another day…”), but one imagines that the breaking point would be a selloff in equities that catalyzes a safe-haven bid.

“[The] most topical question at the moment is how long will the Fed remain comfortable with the price action – particularly given the reality that once a more significant correction takes hold, it will require an even larger policy response to offset,” BMO’s Ian Lyngen said. “The concept of a preemptive round of fresh accommodation certainly isn’t foreign to the Fed [but] exercising the Powell put too early runs the risk of even further exaggerating the stretched valuations.”


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