Risk/Reward Vol. 407
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL RELFECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Two news items rallied stocks on Friday resulting in the major indices remaining flat for the week. The first was the temporary settlement of the government shut down. That was inevitable. The second was less touted but will have a much more lasting impact on investors. In Friday's Wall Street Journal it was reported that the Federal Reserve is weighing an earlier than expected end to its portfolio reduction program. This is a disappointment for fixed income investors, such as yours truly. It signals that the era of cheap and plentiful credit may continue. If true, stock buy backs fueled by inexpensive borrowing will continue, much to the benefit of stockholders. TINA (There Is Not Alternative--to stocks) may be returning.
Why does the curtailment of the Fed's portfolio reduction program portend poorly for fixed income (bond) investors? A little history is in order. In the aftermath of the 2008 financial crisis, the Federal Reserve reduced short term (Fed Funds) interest rates to near zero with the dual purpose of reducing the cost of borrowing and discouraging savings. The intention was to spur consumer consumption and concomitantly economic growth. Believing that that effort was insufficient, the Fed also reduced longer term interest rates by literally printing more money, increasing its balance sheet from $800 billion to $4.5 trillion and outbidding virtually every other buyer of long term Treasury bonds and mortgages. This effort caused the interest rates borne by those securities to plummet. (Remember, the higher the bid price, the lower the interest rate.) The impact of this "Quantitative Easing" was monumental. The interest rate on the US Ten Year Bond plummeted from 4- 5% to well below 2%. It now rests at a meager 2.75%. Similar QE efforts around the world had an even greater impact with much of the world's sovereign debt yielding a NEGATIVE return (invest 100 Euros and get 98 back in ten years). In 2018, many central banks realized that government intervention via lowering short term rates and quantitative easing was not sustainable. Several such banks announced that overnight rates would gradually increase, that QE would end and that they would start selling their portfolio of bonds into the market. The obvious impact of these efforts would be and was a rise in interest rates across the board---a return to normalcy if you will.
But Friday's news story from the Fed (and a similar one reported earlier in regard the European Central Bank) plus a previously announced halt to short term rate increases in 2019 are nothing short of a reversal of the decisions made in 2018. With the economies of the world doing well, one is left to wonder why. The answer is obvious, if underreported. In cheapening the cost of money (lowering rates) and printing money this past decade, central banks have created a debt bubble of historic proportions. Global sovereign (government) debt is an astounding $66Trillion or 80% of global GNP. The situation in the US is just as bleak. In 2007 before the financial crisis and the Fed's financial engineering projects, the US national debt was $9Trillion which was serviced by income tax collections of $1.5Trillion. Currently, the US debt is $22Trillion (2 1/2 times what it was in 2007) serviced by $2.5Trillion in income tax collections of which nearly 15% is devoted to interest payments. If the interest rate on the US debt were to double (which it would if rates were normal), debt service would consume 30% of tax revenue. In other words, we couldn't service our debt and otherwise run our government. Duh! Given this upward spiral of debt, logic dictates that central banks will do even more to suppress rates. Bond holders may be lucky to get their principal back--- let alone any interest. Think not? Take a look at Puerto Rican bonds. Very depressing. I may have to rethink my fixed income strategy
No comments:
Post a Comment