Author: Jonathan Tunney, Atlas Capital
The capital markets continue down their uncertain saw-tooth path, alternating between fear induced flight-to-quality and greed-seeded pops in global equity indices.
Current market conditions are affected by:
- It's the summer; volumes are traditionally lighter.
- Dim US growth prospects and declining Euro-zone GDP.
- Poor performance by the year's largest IPOs.
- Most importantly, uncertainty surrounding the viability of the euro.
We've seen negative short sovereign debt yields before, but clearly they are becoming a little more the norm. Market participants are willing to pay the Swiss or Danish governments to hold their investment capital; Give the Swiss $100, you'll get back $99 in two years.
Our first thought is to buy a safe and keep it in your basement. However, given some of the capital flows in question, that could require a pretty big safe.
There's a small amount of logic for buying expensive Swiss or Danish debt; they each have their own currency and it's not called the euro.
That illustration does not explain why German yields are negative out to 2015 and Finnish yields are inching their way to that area. Both of those countries use the euro though, and yes, their financial condition is better than their Mediterranean colleagues.
Yields are negative because the immense hunt for safety by European capital dwarfs the capacity of these respective bond markets to absorb the flow.
It is only a matter of time before the capital starts moving more aggressively to the two largest bond markets in the world - USA and Japan. Unless, of course, the sovereign states that make up the euro are willing to give up substantial fiscal control over their own economies. We have a tough time believing the Bundestag will abdicate some of its elected authority to some central bureaucratic authority in Brussels.
What does this mean to you, a US resident?
Well, it's as we've stated before, things are bad here, but they are worse everywhere else.
Rates will continue to stay low for several years. The US dollar is the only currency able to absorb massive capital inflows. Our bond market is the largest in the world.
The demographics in Japan are appalling and their debt-to-GDP ratios are two times ours.
As absurd as it sounds, a case can be made for US rates going lower.
One day, rates will go up, but not for a while. Do a little bond math and it's clear that the upside is limited from current levels and the downside, when it occurs, could be on the order of 20%.
Safety is absurdly rich. Risk is cheap.