Strange Things Are Happening in European Bond Markets

By Christine HughesCanada. Chief Investment Strategist, OtterWood Capital:

Strange things are happening in the European fixed income markets these days as our friends at RenMac pointed out this week. I watch these indicators too, and my jaw is on the floor as I watch their QE program unfold.

For starters they are buying 260% of all net bond issuance with their program. That means they are buying up more than 2.5 times what they are going to issue (less what will mature). What will be left looks like the red line on this chart:

2015-04-17-otterwood-Expected-outstanding-German-Gov-Bonds

Having supply sucked out of the system like that has an obviously large impact on prices. The more buyers there are of anything, the higher the price goes (and in the case of bonds, the lower the yields go).

As of this week German government bond yields are negative all the way out to 9 years in maturity. So that means to park your money in Germany for the next 9 years, you have to pay THEM. That is so backwards I can’t even begin to think of all the unintended consequences this will bring about.

2015-04-17-otterwood-yield-curve-German-Gov-Bonds

The bigger question for me is if this heavily distorted government bond market is the reason for European swap spreads blowing out. Swap spreads are an indication of credit health of a given market. Higher swap spreads indicate financial stress, lower indicate easier, more benign conditions. Shown below are European 10yr swaps spreads on the rise since their QE began.

2015-04-17-otterwood-European-swap-spreads

Are they rising because of the negative yields created by the ECB or are they actually indicating a growing risk of default in the Eurozone? With what’s going on with Greece (see here from my prior comment), it could very well be indicating that stress! In any event, it is well worth keeping a close eye on these indicators of financial stress. By Christine Hughes, OtterWood Capital

In the US, junk-rated corporations are already showing what signs of what materials their debts are made of. Read…  Bankruptcies Suddenly Soar Across Corporate America, Worst First Quarter Since 2009

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  11 comments for “Strange Things Are Happening in European Bond Markets

  1. Mick
    Apr 19, 2015 at 10:51 am

    Looking like a summer crash. Have to bring the system down before the IMF meeting in September, the meeting they have only once every five years to discuss things like world reserve currencies, the SRD, and so on.

    FED will either raise rates in June or announce a September rate raise, either will crash the market just fine.

    • Hendrik1730
      Apr 20, 2015 at 6:20 pm

      The FED will NOT raise rates; the US is just broke to the hilt. 18+ trillions in debt, a trade balance in dark red for years now and unfunded liabilities from here to eternity ( Obommercare, pensions, Muni bonds, student loans, and now a new subprime car loan scam, big corporates Cies byuing back stocks using zero interest debt in order to boost Earnings/Share – not to mention IBM/Apple e.g. ) …. and NOW raising interest rates? Give me a break …

  2. Yancey Ward
    Apr 19, 2015 at 1:01 pm

    If, ultimately, all government borrowing is financed by direct monetization, what should the interest rate on the paper be? My theory is that the rate should be same as on a cash note- zero- since it is just governments printing money for the spending. In that limiting case there is no “lender”.

  3. Spencer
    Apr 19, 2015 at 4:49 pm

    And these high priced bond buyers are sucking this crap in? Well pardon me for not knowing that I have to pay someone keep my fiat at negative rates! If these dummies buy this crap, shame on them. Hold gold for nine years and see what happens. This is where the fiat should be going, and I am a financial know nothing. Unbelievable!

    • Gil Obrero
      Apr 19, 2015 at 8:11 pm

      Oh no Spencer,

      On the contrary you have common sense and can see quite clearly as many of can that something that is actually worth something, costs something.

      When the rent gets so cheap you have to start asking yourself what kind of toilet are getting for your money, and when they start to pay you as in negative yields to borrow, then you have to ask what toxic liabilities come attached.

      Nothing is for free that has any value and the filthy euro coupon just got flushed down the toilet and if you are holding any, you might want to check your fingers.
      Something very nasty is attached and I have a feeling it is not going to be too long before the smell starts to creep into peoples consciousness

    • Hendrik1730
      Apr 20, 2015 at 6:25 pm

      Same applies to me : I am an equally supposed dumb non-financial guy ( actually, a scientist ) and I couldn’t agree more. Hold tight, don’t waver, the long run will prove us RIGHT. By the way, if you buy gold, only PHYSICAL and keep it out of the banking system. Just saying …

  4. jill
    Apr 19, 2015 at 6:30 pm

    The German yield curve is now flat at just above zero from overnight to 10-year….is that something to worry about?

  5. Dan Romig
    Apr 20, 2015 at 7:07 am

    Why would an individual buy 10 year bonds from Switzerland at a negative yield? Wouldn’t one be better off simply holding Swiss francs instead? This applies to all other central banks and fiat currencies.

    I took Stanley Druckenmiller’s advice recently, and picked up a bit of EUO to bet that the euro falls more against the dollar.

    • JamesD
      Apr 20, 2015 at 7:45 am

      If you hold it in Swiss Francs, that means you hold it in the bank. Shows you they don’t trust the banks.

      • Dan Romig
        Apr 20, 2015 at 9:05 am

        Or, one could store fiat currency in fire-proof safe at a secure location. Safety deposit boxes and bank accounts may not be exempt from government confiscation. Ask those who banked in Cyprus. And remember what FDR did to law abiding citizens who held gold bullion in 1933!

        • Hendrik1730
          Apr 20, 2015 at 6:28 pm

          One more reason to NOT keep your gold in a bank vault. Dig a hole in your back garden and try not to forget where it was.

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