The Bond Bubble
Have years of ZIRP, NIRP and QE created a global bond bubble? The evidence seems to suggest that it has. Upwards of $13 trillion of government bonds in Germany, Japan, and the Netherlands in particular are trading at rates below zero. Even some corporate bond issues have recently been completed at rates below zero.
Global debt has increased at an astronomical pace since the financial crisis of 2008. It is estimated that global debt has jumped at least $90 trillion, an astounding 64% increase in just 8.5 years. The main culprits have been governments and corporations.
China is a serial borrower and may have seen the biggest increase, all to finance their massive expansion. In its wake, it has left a possible real estate bubble with few signs that there are actually any people to occupy the cities that have been built. China’s corporate and financial sector have been the chief borrowers.
But it is not just China, as companies borrowed to buy back their stock and other non-productive uses. Problems are growing in the EU banking system, particularly with Deutsche Bank (DE:DBKGn), the EU’s second-largest bank. The Italian banking system is teetering on the edge of bankruptcy, and depositors are facing unprecedented bail-ins. Low interest rates have encouraged borrowings and then those funds have been used to buy real estate and stocks, creating further bubbles.
The question is not if, but when something goes wrong to trigger an avalanche of selling, and another global financial panic that would no doubt be larger than 2008. Yet, few are paying attention. Interest rates today are lower than at any time in history, a rather remarkable fact given that interest rates can be traced back to 3,000 BCE.
Weekly Market Review
Stocks
Despite numerous predictions of an impending market collapse, the US stock markets continue to hang in. Markets were up this past week with the Nasdaq once again setting a new all-time high. Markets reacted positively to the debate on September 26, 2016, as Clinton is preferred to Trump. But watch out, as the follow through was feeble. The Dow Jones Industrials (DJI) breaks down under 18,000 and the S&P 500 under 2,140. We also note Germany’s DAX index, particularly with the current woes of Deutsche Bank. The chart looks quite toppy and a decline there could soon get underway, dragged down by the EU banks, led by Deutsche Bank.
Bonds
If the stock market looks feeble and could fall, the bond market is starting to look like it could have the rug pulled out from under it. While interest rate yields fell this past week (prices that move inversely to yields rose), the yields were bouncing back after backing up. A test of the recent lows is possible. But one of the key ones to watch is the high-yield market, where theiShares iBoxx $ High Yield Corporate Bond (NYSE:HYG) continues to move to new highs, despite signs over in the US Treasury market that yields may have bottomed.
The high-yield market is particularly vulnerable, as people have piled into it looking for those higher yields. However, they are also forgetting it is a very small market, and if everyone were to rush for the door at once liquidity would become a major problem. As we note under our discussion of bond bubbles, illiquidity is a growing concern in the global bond markets.
Currencies
The sideways neutral patterns on the major currencies continues. We stress that we don’t know which way they are going to break, as there are technical and fundamental arguments both ways. That would see the USD index rise or fall, and the euro do the opposite. Given the woes in the EU, one would think that the euro should fall. But conventional wisdom can often be turned on its ear. October 1, 2016 marks the insertion of the Chinese yuan into the IMF’s SDR.
The Chinese yuan will now constitute over 10% of the SDR. It helps set up the yuan to become free trading. Does entry into the US$ Index follow? The Chinese have touted the SDR as a possible replacement for the USD as the world’s reserve currency. We are sure the US won’t want that.
Gold and Precious Metals
Both gold and silver were down on the week, particularly following the September 26, 2016 debate, as gold and silver would prefer a Trump presidency. Odd, as both candidates would be positive for gold and silver. Once again, gold has held above $1,300 and while silver dipped briefly below $19, it continues to hold above $18.70. The fundamentals for gold and silver remain strong but the short-term technical picture is cloudy, suggesting that some lower prices remain possible.
The gold stocks are holding in remarkably well, suggesting to us that the near term remains in a corrective phase. This remains a patience game awaiting a breakout to the upside, but another near-term low cannot be ruled out. The commercial COT improved this week, and it is a sign that the commercials are covering their shorts.