Since 2008, Central banks have had a dual mandate, first and foremost to bid up risk assets and generate the all-important trickle down fake wealth effect. Secondly, they attempt to reflate the economy, on a lagged basis of usually 6 to 9 months. If they are unsuccessful in reflating the economy of course, their sole achievement is to create a chasmic gap between fantasy and reality.
Right now, global bond markets reacting to central bank liquidity stimulus, are rushing straight into risk based on the premise of a weakening global economy. Which means they are making two proven wrong and incompatible assumptions 1) that yields will continue to fall as central banks pump more money and 2) that default risk will continue to fall if CBs fail to reflate the economy. When either of these assumptions proves incorrect, credit markets blow up, again.
In other words, this is either 2016 - successful economic reflation bond implosion caused by rising yields. Or it's 2007, unsuccessful economic reflation bond implosion leading to domino crash.
Either way, the ultra-crowded RISK ON deflation trade is doomed.
What Pavlovian gamblers STILL haven't learned - because most of them are silicon-based anyways, is that the METHOD of central bank reflation is to push long-term bond yields lower, however the GOAL of central bank reflation is to force them higher.
We've seen this exact same movie three times in five years:
Three years ago in July 2016, the Shanghai Accord stimulus peaked. German bund yields (red) which had been crashing, backed up, and the deflation trade ended, as we see via U.S. REITs. The same thing happened in 2015 on the left side of the chart. Stocks peaked when yields rose.
Where this gets interesting is the collapsed default premium into the slowing economy. As it was in 2007, by misallocating capital, investors have "diminished their own perceptions of risk".
A self-induced Jedi Mind Trick, with the aid of central banks:
"The hunt for yield is making parts of the U.S. corporate bond market look a lot like 2007"
I call this the "Inefficient Market Hypothesis" because it negates everything I learned in business school. At the riskiest point in the cycle, the credit market was/is conveying low risk, simply because liquidity is being used as a proxy for solvency.
Which is the definition of Ponzi borrowing.
"The increased size, lower quality and lack of liquidity in corporate bond markets are all red flags, Mather said. He also sees credit risk from duration -- a measure of the sensitivity of bonds to shifts in interest rates."
July 12th, 2019
ZH: Here Is How Muppets Should Play The Melt-Up
So why isn't this the 2016 "best case scenario" selloff?
It could very well start the same way - a panic backup in yields from record low levels as viewed above. However, the decimation of bonds and bond proxies may not be "contained" this time. Specifically, anything requiring easy access to credit - say the oil market or anything with a high P/E ratio or non-existent profits, will get re-priced back to reality.
"As long as the global economy keeps cratering, this will all be fine"
"He referred to this year’s record stock buybacks, much of them financed with leverage, as hazards for corporate bond investors."
Picture the stock buyback bubble imploding stocks.
