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I’m starting to entertain the idea of a massive bubble in bonds. Is inflation really never going to show again? I can’t understand why anyone would want to ho

by gzu 7y ago

I’m starting to entertain the idea of a massive bubble in bonds. Is inflation really never going to show again? I can’t understand why anyone would want to hold a fiat currency for 30 years for no return. Is it due to portfolio theory where the assumption is stocks and bonds yields have inverse correlation and the way to manage risk is to have a correct ratio? Due to global QE there is too much money floating without enough to invest. What’s the alternative to equities and/or bonds

RockIslandLine 7y ago
"Is inflation really never going to show again?" What causes inflation? Inflation is too much money chasing too few goods and services. When populations are growing, you need to expand the money supply to avoid deflation. What happens when populations stop growing?
- paulpauper 7y ago
  Turkey and other economically weak countries have high pop growth and high inflation and high bond yields, so that is not the answer. it has more to do with flight to safety. Countries that are perceived as economically strong and geopolitically stable have low yields, countries that are weak have high yields ,regardless of pop growth.
adventured 7y ago
> Is inflation really never going to show again? In developed economies money is being removed nearly as fast as it's being added, in the form of going into the blackhole of low to negative yielding paper. It's removing a present ~$17 trillion of capital that could otherwise be sloshing around pressing inflation higher. That's an extraordinary amount of money that has largely been rendered non-impacting. There are only a few areas where you see any inflationary pressure in the US, such as in assets like equities and real-estate, due to the Fed rates. In that case you've got people with immense collective free capital pressing aggressively upward on prices (willing to pay a high premium to try to get a return beyond what eg treasuries are offering). It's why Japan can never spark traditional inflation (nor achieve any growth). Their epic pile of low yield debt has sucked a lot of the loose capital out of their economy. It's a giant pile of non-productive, non-active, ineffectual capital. Instead of going toward wage pressure / competition, growth, business formation & loans, VC, productivity investments, R&D, et al. If you could unleash $20-$30 trillion of increasingly low yielding debt back into the US economy, inflation would skyrocket and it would demand far higher rates to control inflationary pressure. It takes several things working in tandem to result in this unusual outcome. Countries outside of the developed world - the first tier, affluent economies - have a near impossible time achieving such low or negative yields, and lack of inflationary pressure.
- marvin 7y ago
  I still don't understand this at all. Is all this money that's being parked in almost no-yielding bonds just going to stay there forever, never to be used? What does this say about the state of the economy or the expectations/psychology of whomever buys them? There's either something very hard to understand that's happening to the world economy, or it's just a strange phenomenon that people pretend to understand but don't.
  - jdhn 7y ago
    >Is all this money that's being parked in almost no-yielding bonds just going to stay there forever, never to be used? The money can come back out, however it seems very difficult to see when that'll happen. That being said, if it does happen, I think we'll see a lot of inflation due to the sheer amount of money that would be pouring into the system.
lixtra 7y ago
I think ECB is doing a terrible job in reaching their stated goal of 2% inflation. I think actual helicopter money distributed equally to each EU citizen (a few hundred EUR) would have been much better than buying state bonds. Most people would have spent the money immediately and thus caused the desired inflation. As it is now the states benefit from QE in the first step, used in questionable projects in the second step and then it doesn’t tickle down but just inflates various financial asset bubbles. It’s neither fair nor effective. Of course you need some thought, how to actually distribute the money without losing to much on bureaucracy, but it is possible.
- a_f 7y ago
  I too am starting to believe helicopter money could be a potential solution. Although I have to say my understanding of economics is pretty limited
hogFeast 7y ago
No. The deal with bonds is that they have just been a way better risk-adjusted investment than stocks. An optimal portfolio still owns stocks but the point of all these approaches (risk-parity, much of the hedge fund industry pre-2008) was just owning levered govt bonds...that was it. Correlation is a minor part of that story (although it is very important). And this effect isn't driving the price (imo). What is driving this is risk aversion, central banks, and regulatory requirements to hold risk-free securities (most investors aren't sophisticated enough to be doing portfolio math). Also, it is no coincidence that the worst affected countries (Germany/Japan) are those with risk-averse populations, crazy central bankers, and completely dysfunctional banking sectors. The alternative is: property, commodities, private business, etc. But remember, the financial world has gone crazy...but the rest of the world is just going on as normal. This is part of the problem: central bankers believed they were geniuses and could control the real economy by fiat...well, they can't. Their world will go down in flames but everything else will likely continue as normal. Investing is not about risk-free rates or volatility/beta-adjusted portfolios, it is about providing capital to business for growth. These opportunities still exist, the financial world of central banks is (these days) unrelated to this.
- samsonradu 7y ago
  > Their world will go down in flames but everything else will likely continue as normal. > These opportunities still exist, the financial world of central banks is (these days) unrelated to this. It's not unrelated at all. It's the central banks policies that are pushing the economy out of balance. These policies obfuscate the real risks that come with investing, like defaults and money-losing investments. Greece, a country close to default a few years ago and with a debt-to-GDP ratio of 180% in a currency it cannot print manages to have a 10Y yield of ~2%. Not predicting any doomsday but I believe in the upcoming years EU banks will slowly push the negative interest rates down to consumers, as they have no alternative. Their business model of borrowing-short and lending-long is no longer sustainable. Also, on the long run, these policies have the effect of shrinking the middle-class, increasing inequality and polarising societies.
FPGAhacker 7y ago
As posted elsewhere in the comments, this link went a long way to explain it for me: https://portfoliocharts.com/2019/05/27/high-profits-at-low-rates-the-benefits-of-bond-convexity/ https://portfoliocharts.com/2019/05/27/high-profits-at-low-r...
- gzu 7y ago
  Thanks for the link! My take from that is the bubble is even worse than I thought. I didn’t realize the capital appreciation part and how sensitive long term notes are to rate changes. It seems to more or less work on the greater fool theory between central banks and investors. The intrinsic value held within the bonds is not there and where is the stopping point on the negative side? There’s a discrepancy between Central banks lower rates and bid up bonds through QE so bonds rates are continually on the decline and investors use that rate lowering for returns when bonds appreciating in value. The amount of compounding leverage here between all parties would mean the system would implode if bonds went the other way for a longer duration. Maybe this threat of implosion only further accelerates lowering of rates as there is no alternative and even systemic deflation risk.

by gzu 7y ago

RockIslandLine 7y ago

"Is inflation really never going to show again?" What causes inflation? Inflation is too much money chasing too few goods and services. When populations are growing, you need to expand the money supply to avoid deflation. What happens when populations stop growing?

paulpauper 7y ago
Turkey and other economically weak countries have high pop growth and high inflation and high bond yields, so that is not the answer. it has more to do with flight to safety. Countries that are perceived as economically strong and geopolitically stable have low yields, countries that are weak have high yields ,regardless of pop growth.

adventured 7y ago

> Is inflation really never going to show again? In developed economies money is being removed nearly as fast as it's being added, in the form of going into the blackhole of low to negative yielding paper. It's removing a present ~$17 trillion of capital that could otherwise be sloshing around pressing inflation higher. That's an extraordinary amount of money that has largely been rendered non-impacting. There are only a few areas where you see any inflationary pressure in the US, such as in assets like equities and real-estate, due to the Fed rates. In that case you've got people with immense collective free capital pressing aggressively upward on prices (willing to pay a high premium to try to get a return beyond what eg treasuries are offering). It's why Japan can never spark traditional inflation (nor achieve any growth). Their epic pile of low yield debt has sucked a lot of the loose capital out of their economy. It's a giant pile of non-productive, non-active, ineffectual capital. Instead of going toward wage pressure / competition, growth, business formation & loans, VC, productivity investments, R&D, et al. If you could unleash $20-$30 trillion of increasingly low yielding debt back into the US economy, inflation would skyrocket and it would demand far higher rates to control inflationary pressure. It takes several things working in tandem to result in this unusual outcome. Countries outside of the developed world - the first tier, affluent economies - have a near impossible time achieving such low or negative yields, and lack of inflationary pressure.

marvin 7y ago
I still don't understand this at all. Is all this money that's being parked in almost no-yielding bonds just going to stay there forever, never to be used? What does this say about the state of the economy or the expectations/psychology of whomever buys them? There's either something very hard to understand that's happening to the world economy, or it's just a strange phenomenon that people pretend to understand but don't.
- jdhn 7y ago
  >Is all this money that's being parked in almost no-yielding bonds just going to stay there forever, never to be used? The money can come back out, however it seems very difficult to see when that'll happen. That being said, if it does happen, I think we'll see a lot of inflation due to the sheer amount of money that would be pouring into the system.

lixtra 7y ago

I think ECB is doing a terrible job in reaching their stated goal of 2% inflation. I think actual helicopter money distributed equally to each EU citizen (a few hundred EUR) would have been much better than buying state bonds. Most people would have spent the money immediately and thus caused the desired inflation. As it is now the states benefit from QE in the first step, used in questionable projects in the second step and then it doesn’t tickle down but just inflates various financial asset bubbles. It’s neither fair nor effective. Of course you need some thought, how to actually distribute the money without losing to much on bureaucracy, but it is possible.

a_f 7y ago
I too am starting to believe helicopter money could be a potential solution. Although I have to say my understanding of economics is pretty limited

hogFeast 7y ago

No. The deal with bonds is that they have just been a way better risk-adjusted investment than stocks. An optimal portfolio still owns stocks but the point of all these approaches (risk-parity, much of the hedge fund industry pre-2008) was just owning levered govt bonds...that was it. Correlation is a minor part of that story (although it is very important). And this effect isn't driving the price (imo). What is driving this is risk aversion, central banks, and regulatory requirements to hold risk-free securities (most investors aren't sophisticated enough to be doing portfolio math). Also, it is no coincidence that the worst affected countries (Germany/Japan) are those with risk-averse populations, crazy central bankers, and completely dysfunctional banking sectors. The alternative is: property, commodities, private business, etc. But remember, the financial world has gone crazy...but the rest of the world is just going on as normal. This is part of the problem: central bankers believed they were geniuses and could control the real economy by fiat...well, they can't. Their world will go down in flames but everything else will likely continue as normal. Investing is not about risk-free rates or volatility/beta-adjusted portfolios, it is about providing capital to business for growth. These opportunities still exist, the financial world of central banks is (these days) unrelated to this.

samsonradu 7y ago
> Their world will go down in flames but everything else will likely continue as normal. > These opportunities still exist, the financial world of central banks is (these days) unrelated to this. It's not unrelated at all. It's the central banks policies that are pushing the economy out of balance. These policies obfuscate the real risks that come with investing, like defaults and money-losing investments. Greece, a country close to default a few years ago and with a debt-to-GDP ratio of 180% in a currency it cannot print manages to have a 10Y yield of ~2%. Not predicting any doomsday but I believe in the upcoming years EU banks will slowly push the negative interest rates down to consumers, as they have no alternative. Their business model of borrowing-short and lending-long is no longer sustainable. Also, on the long run, these policies have the effect of shrinking the middle-class, increasing inequality and polarising societies.

FPGAhacker 7y ago

As posted elsewhere in the comments, this link went a long way to explain it for me: https://portfoliocharts.com/2019/05/27/high-profits-at-low-rates-the-benefits-of-bond-convexity/ https://portfoliocharts.com/2019/05/27/high-profits-at-low-r...

gzu 7y ago
Thanks for the link! My take from that is the bubble is even worse than I thought. I didn’t realize the capital appreciation part and how sensitive long term notes are to rate changes. It seems to more or less work on the greater fool theory between central banks and investors. The intrinsic value held within the bonds is not there and where is the stopping point on the negative side? There’s a discrepancy between Central banks lower rates and bid up bonds through QE so bonds rates are continually on the decline and investors use that rate lowering for returns when bonds appreciating in value. The amount of compounding leverage here between all parties would mean the system would implode if bonds went the other way for a longer duration. Maybe this threat of implosion only further accelerates lowering of rates as there is no alternative and even systemic deflation risk.