The bond market vigilantes are back. And they clearly don't like what they are seeing. That is the clear message from the charts above, showing movements in 10-year government bond interest rates for the major economies, plus their exchange rate against the US dollar and the value of the US dollar Index:
- As I warned in August, Suspense rises as Great Unwinding Becomes The Great Reckoning
- The financial world has completely changed since the Brexit vote in June, and then Donald Trump's election
- The Brexit vote saw rates begin to surge and the US dollar to rise; these moves have accelerated since Trump's win
- Since the Brexit vote, US rates have risen by more than a half from 1.4% to 2.3%
- UK rates have trebled from 0.5% to 1.5%
- Chinese rates have risen by more than a tenth from 2.6% to 2.9%; Japanese rates have risen from -0.3% to zero
- German rates have risen from -0.2% to a positive 0.3%; Italian rates have doubled from 1% to 2%
At the same time, the value of the US dollar has been surging against all these currencies, as the black line in each chart confirms. And the value of the US dollar Index against the world's major currencies has risen by 8% to $101.
These are quite extraordinary moves, and it is most unlikely they will be quickly reversed. They mark the start of the Great Reckoning for the failure of the stimulus packages introduced on an ever-larger scale over the past 15 years.
Now investors are going to find out the hard way that return on capital is not the same as return of capital, due to the return of the bond market vigilantes. As James Carville, an adviser to President Bill Clinton once warned:
"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."
The key issue is that the demographic dividend of the BabyBoomer-led Super Cycle is now creating a demand deficit. The 50% rise in global life expectancy since 1950, combined with the 50% decline in fertility rates, means that we have effectively traded 10 years of increased life expectancy for economic growth. That's not a bad trade, and I have yet to meet anyone who would volunteer to die early, in order to allow growth to return.
The problem is that in recent years, policymakers have chosen to ignore these demographic realities. They have instead assumed they can always create growth via stimulus programs based on ever-increasing amounts of debt.
Today, we therefore now face the problem of high debt ($199tn according to McKinsey and 3x global GDP, last year), and no growth. So as William White of the OECD warned in January, investors are now beginning to realize all this debt can never be repaid.
These developments also highlight how central banks are now starting to lose control of interest rates. Instead, markets are beginning to rediscover their real role of price discovery based on supply/demand fundamentals. They are no longer being overwhelmed by central bank liquidity:
- The interest rate rises will have major impact on individuals and companies, as prices realign with fundamentals
- A rising dollar is also deflationary for the global economy, as it further reduces growth levels outside the USA
- In addition, it is bad news for anyone who borrowed in dollars, thinking they would benefit from a lower interest rate from that available in their own country, as their capital repayments increase
The problem, of course, is that it will take years to undo the damage that has been done. Stimulus policies have created highly dangerous bubbles in many financial markets, which may well burst before too long.
It is still possible to hope that "something may turn up" to support "business as usual" Budgets. But hope is not a strategy. Today's economic problems are already creating political and social unrest. And unfortunately, the outlook for 2017-2019 is that the economic, political and social landscape will become ever more uncertain.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.