Bond Bears: Beware of “crypto QE”
The guys at Variant Perception make a great point. Some reform plans for the banking sector (so-called “narrow banking” being the most extreme) would have banks invest more deposits in government paper in order to keep them safe. To the degree such plans get traction, that could keep a lid on yields despite rising government spending.
The following chart shows how the US 10yr yield has disconnected from the price of commodities. We believe yields are not reflecting the future risk of inflation, and the fiscal situation of many sovereign issuers. However, there are no limits to what governments may do to support their debt. In the UK, a recent ruling was announced by the FSA forcing banks to increase their holdings of government bonds. In India a similar initiative has just been announced. In Japan, already over 50% of outstanding JGBs are owned by public sector institutions. In the US, only 0.9% of commercial banks’ assets are treasuries; in 1994 it was as high as 8.7%, so there’s great scope for it to increase. Mandated purchases of government bonds by banks and other financial institutions – crypto-quantitative easing – could persist long after official QE comes to an end, keeping bond markets supported for longer than many think.
Nevertheless, we think longer-term yields will move higher. Sell rallies.