Chasing Yield during ZIRP & NIRP Evidently Starved Human Brains of Oxygen. Now the Price Is Due

See Argentina’s 100-year dollar-bond and emerging-market “turmoil” as the Hot Money flees.

Let’s be clear: It’s not just Argentina. But Argentina is the most elegant example. The exodus of the hot money from emerging markets where cheap dollar-debts were used to fund pet projects and jack up leverage is – once again – in full swing. Cheap dollar-debt in emerging markets is an old sin that, like all old sins, is repeated endlessly. The outcome is always trouble. But during the act, it sure is a lot of fun for everyone.

The exodus of the hot money is even gripping the non-basket-case emerging economies of Asia where it’s causing the worst indigestion since 2008. Bloomberg:

Overseas funds are pulling out of six major Asian emerging equity markets at a pace unseen since the global financial crisis of 2008 – withdrawing $19 billion from India, Indonesia, the Philippines, South Korea, Taiwan, and Thailand so far this year.

While emerging markets shone in the first quarter, suggesting resilience to Federal Reserve tightening, that image has shattered over the past two months. With American money market funds now offering yields around 2% – where 10-year Treasuries were just last September – and prospects for more Fed hikes, the bar for heading into riskier assets has been raised.

“It’s not a great set-up for emerging markets,” James Sullivan, head of Asia ex-Japan equities research at JPMorgan Chase, told Bloomberg. “We’ve still only priced in about two thirds of the US rate increases we expect to see over the next 12 months. So the Fed is continuing to get more hawkish, but the market still hasn’t caught up.”

Emerging markets have responded to this new environment and a newly hawkish Fed with all kinds of gyrations, including raising rates in order to prop up their currencies. For example, the central banks of Argentina and Turkey hiked key rates to 40% and 17.75% respectively.

But don’t blame the Fed – that’s what outgoing New York Fed President William Dudley told reporters, after Reserve Bank of India Governor Urjit Patel had blamed the Fed via an op-ed in the FT, titled ominously, “Emerging markets face a dollar double whammy.” Patel told the Fed to slow down the QE unwind that is now accelerating.

“Dollar funding of emerging market economies has been in turmoil for months now,” Patel wrote – because yeah, the era of the cheap dollar is over, and investors should have figured that out two-and-a-half years ago when the Fed started hiking rates. But the market didn’t want to believe that the Fed would actually do it. And suddenly over the past two months, it dawns on these geniuses that the Fed has actually been hiking rates and will continue to do so for some time.

Patel not only blamed the QE unwind but also the simultaneous and massive issuance of new Treasury debt by the US government to fund its ballooning deficits. This new issuance of Treasuries “will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.”

OK, I’ve been singing about this “crisis” in the dollar bond market for a while, except I don’t call it a crisis because it’s not a crisis: It’s just that it will get a lot more expensive to borrow in dollars. And no one forced these guys to borrow in dollars. So get used to it, Mr. Patel, and quit whining.

Dudley rejected that type of criticism from an emerging-market central bank. “There has been some spillover, potentially, to emerging-market economies, but again, it’s also hard to sort of say how much of that is due to the normalization of the balance sheet versus other factors,” Dudley said, according to Bloomberg:

He cited large fiscal and current account deficits in many emerging markets, which he said “probably would have been problematic in any case, so sort of laying this all at the feet of the balance sheet normalization process, I think, is probably going a little bit too far.”

So don’t cry for Argentina’s investors that inexplicably bought $2.75 billion of 100-year bonds with a 7.125% coupon in June last year, at the peak of the cheap dollar-debt benightedness.

Everyone knew that Argentina would default on these bonds before they’d mature, as it has defaulted repeatedly on its foreign-currency debts, and that it was only a question of when it would default and how many times.

But the lure was just too juicy to not bite, in an environment where central-bank shenanigans (NIRP) were producing negative bond yields in Europe and Japan. And even in the US, ZIRP was still not fully banished. In the ensuing pandemic chase for yield, which had lasted years, investor brains were systematically starved of oxygen.

Argentina sold these “century bonds,” which mature in 2117, at 90 cents on the dollar – and investors thought they’d gotten a sweet deal. And they sure had if they sold the bond when it peaked on October 30 at 103.94. This gave sellers a profit of 15%. Those that didn’t sell or that bought at the time are ruing the day.

The bond has since plunged 23% to 79.98 cents on the dollar by Friday, and is down 11% from the price when issued (chart via Bloomberg, click to enlarge):

The thing is, Argentina hasn’t even defaulted on it yet, though 11 months after selling the bonds, it has already gone begging to the IMF for a bailout. And the IMF, in another bout of debt-benightedness, has agreed to lend it $50 billion. But those $50 billion won’t be used to pay off the century bond. They’ll be plowed into government spending and will disappear, leaving Argentina with an additional $50 billion in dollar-debt.

It’s not crazy for Argentina to have undertaken this piece of 100-year gaucho showmanship – in fact, you have to admire it for being able to pull it off. But it’s crazy for investors to have fallen for it.

But now investors, including the hot money, are once again getting burned in the emerging markets, and the emerging markets are once again getting burned by their exodus. You’d think someone might have remembered that from the last few times it happened. But no. These old sins are repeated endlessly.

Why is anyone still lending Argentina’s government any money? Read…  Seems Impossible, but Argentina’s Peso Was Able to Collapse even Further Despite $50 Billion IMF Bailout  
 

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  41 comments for “Chasing Yield during ZIRP & NIRP Evidently Starved Human Brains of Oxygen. Now the Price Is Due

  1. Petunia
    Jun 18, 2018 at 7:36 pm

    Had the bonds been zero coupon bonds they would have been priced at ~1.00. I would have bought one in place of a lottery ticket and not minded when/if they go bust.

    • cdr
      Jun 19, 2018 at 7:46 am

      Great analogy.

      0) With OPM, all manner of bad decision making is possible, probable, and certain as long as the commissions and fees keep flowing. It’s not surprising the junk investing exists, it’s dumbfounding that so many people who otherwise know how to eat, drink, stay clean, and properly use the bathroom keep paying to get fleeced. Stupid and proud of it.

      1) The kind of stupidity as what’s in the article is what makes markets. Markets contain a few kinds of smart and all kinds of stupid with new forms of stupid taking form regularly.

      2) If the Fed went with NIRP, implementing it about now as opposed to taking steps towards normalization, foreign junk bonds would be high demand safe havens.

      3) Regarding point 2, since the lucky find debt issuers just took a big pie in the face and will soon be crap*ing their pants, just think what EU, and maybe Japan, will be going through after rates begin to normalize there. They’re not immune to gravity, no matter how much financial press or how many lying goofy economists claim otherwise. Argentina is a prequel and a blip of a sideshow for the coming main event.

    • Justme
      Jun 19, 2018 at 3:29 pm

      I think you had a momentary brain malfunction there, Petunia. If the Argentina 100year bonds were at 7.125% and had no coupon (meaning: no yearly interest payment) I’m pretty sure the initial price per dollar would have been about 0.1 cents.

      CALCULATE: 1/1.07125**100
      = 0.00102545476359474

      • Petunia
        Jun 19, 2018 at 5:49 pm

        I used an internet calculator and got 1.03 as the price of a 100 year 7.125 zero coupon 1000 face value bond.

        • Jun 19, 2018 at 6:00 pm

          Petunia, my trusty brand-new HP 12c that finally replaced the HP 12c I’d bought in 1985 agrees with your math. It got as present value $1.025.

          But since the bond was sold at a 10% discount, the original yield was actually about 7.9%. So that zero-coupon 100-year bond would have sold for 50 cents, according to HP 12c.

        • Justme
          Jun 19, 2018 at 6:10 pm

          Ah, per 1000 face value, that was the missing part. Then we are in agreement. Wolf’s calculation is even more accurate, taking into account the 10% discount as well.

  2. Steve M
    Jun 18, 2018 at 7:40 pm

    “Fools rush in where in where angels fear to tread.”
    “A fool and his money are soon parted.”
    I thought my old grandmother was just spewing trite, home-spun advice.
    Had no idea she was an economist.

  3. Ragheb
    Jun 18, 2018 at 7:42 pm

    Wonder if some Asian/Latin American countries are being forced to sell gold reserves? Hence the big drop last week

    • R2D2
      Jun 18, 2018 at 11:03 pm

      Nah, last week banksters … I mean bankers sold a lot of paper gold; that is why it was down.

  4. Jun 18, 2018 at 7:55 pm

    Very nice column Wolf. Excellent, as always.

    You’ll get a lot of comments. For my 2 cents, it’s nice to see the re-emergence of real mathematical analysis as a sound basis for investment decisions.

    It’s been absent for a long while, maybe 9 years or so.

  5. Gershon
    Jun 18, 2018 at 8:30 pm

    A deliverance-style reaming awaits many of these hot-money “investors.”

    • cynic
      Jun 19, 2018 at 2:00 pm

      Ah yes, Deliverance:

      We’ve had the musical interlude, so the rest of the tale must unfold, quite naturally…. :)

  6. max
    Jun 18, 2018 at 8:58 pm

    Hot Money flees, flow, exodus, flight, capital outflows are all misleading terms.

    most of the time, money did not go out of the country in the pockets of the people,just digital ownership changed hands.

    American investors do not like any more to hold assets denominated in pesos, rubles, baht, renminbi….

    they are selling those and trying to buy american dollars.


    supply and demand takes effect.

    dollar get stronger — demand is high and supply is low
    emerging markets currency get weaker — demand low and supply high.

    problem is previous inflation by emerging markets governments.

    Gary North
    “Digits do not flow across borders the way that goods and people do. Ownership of digital accounts in one nation’s banks get traded for digital accounts in foreign nations’ banks. The money supply does not change. What changes are the owners of the digits on the various bank accounts. Ownership of digital money shifts. The people trying to exchange dollars for some other currency must find sellers of that currency who are willing to sell. But the total amount of dollars in domestic bank accounts does not change, nor does the total amount of foreign currency digits in foreign bank accounts. Central banks and fractional reserves establish the domestic money supply. Foreign exchange markets do not.”

  7. 2banana
    Jun 18, 2018 at 9:11 pm

    No bailouts. Throw any banker in jail with a whiff of fraud.

    Time for these fools to eat their peas.

  8. peter
    Jun 18, 2018 at 9:39 pm

    Don’t feel sorry for the investors, just think where they got the money to invest in the first place? Probably ripping off some mum and dad investors, insider deals, the odd “illicit” substance here and there, so if they do loose out, it won’t be the end of the world. Us normal people will carry on and won’t be affected much except the cost of our real money will go up to reimburse the fat cats and banks, so same old same old really.
    Good article Wolf, yet again!

    • R2D2
      Jun 18, 2018 at 11:07 pm

      Yeah, it is always baffles me as to how such obvious morons have such huge sum of money at their disposal.

      • OutLookingIn
        Jun 19, 2018 at 12:19 am

        “Starved Human Brains of Oxygen”.

        A “huge sum of money” is what it will cost the taxpayer for the President’s sixth arm of the pentagon. A space force.

        Should be an easy task recruiting members for this space force, since it seems the entire country is mostly populated by space cadets!

      • fajensen
        Jun 19, 2018 at 1:16 am

        Privatisation of pension savings, that’s how.

        Because Markets! Is why. And Now Go Die! will be the only solution offered.

        No wonder that we literally have to bomb liberty and democracy into those crazy foreigners.

      • Beard681
        Jun 19, 2018 at 6:07 pm

        People like us or our fiduciaries “deposit” it with them

    • MC01
      Jun 19, 2018 at 9:13 am

      I don’t know how the situation is in the US, as I haven’t lived there in quite a while, but in Europe private pension funds have been the most enthusiastic buyers of US dollar- and euro-denominated bonds issued in EM. Not only that but they have shown a very strong appetite for so called Methusaleh bonds, meaning bonds with maturities over 30 years, such as those issued by Argentina.

      I fully expect these pension funds to do one of the following:
      1) Quietly reduce their EM holdings, sell off those ridiculous Methusaleh bonds at whatever price, stock up on US Treasuries and investment grade bonds and pretend nothing happened, all the while thanking their lucky star.
      2) Take to streets while beating on their pans and demand a bailout after a half-hearted and mostly unsuccessful attempt to dump those shaky EM bonds upon small banks and retail investors.

      Regardless it will be fun to watch, until a bailout is handed out.

  9. raxadian
    Jun 18, 2018 at 9:50 pm

    Even people in Argentina thought the 100 years bonds were insane and you would have to be an idiot to buy them. Ten year bonds is the most you can expect Argentina to not default on.

  10. Vexser
    Jun 18, 2018 at 10:29 pm

    The real problem is not that it has happened in the past and that it is obviously still happening now. The real problem is that history is scientifically showing us that it will continue to happen into the future. Most of the articles here are thematically identical, just the minutia is different. Since “human nature” will *NOT* change (a scientific fact proven by history), the whole concept of “money” (or even “value”) is proven to be broken and needs to be replaced in light of the lessons of history. As Einstein said: a different level of thinking is required than the one that created the problem(s) in the first place. While I might not be the one to specify a replacement system, surely after all this time of human evolution (and scientific development), the brains to do so must now exist somewhere? The solution will not come from (obviously moronic) “economists” or those who worship numbers (as they are part of the problem). I would suspect that the areas of Anthropology and Psychology would be a more capable of delivering alternatives. Until then, the western system will continue to march toward failure in its hubris (with constant economic “noise” and gyrations), just as many huge civilizations have failed in the past. Just because we are in “modern times” (everyone is *always* in such times) does not mean we, in our hubris are exempt from failure.

  11. nick kelly
    Jun 18, 2018 at 10:44 pm

    This could cause probs close to home.

    Musk says he won’t need to raise more money and that shorts will soon be toast.
    Some majors I think Moody’s for one disagree.
    Tesla’s bonds are technically junk, whatever you think of its prospects.

    But it had no problem placing it’s last issue at I believe around 7 %.
    Those are now trading at 85 cents on the dollar or so (sorry to not be precise but I think that’s close )

    So what will it take when Tesla returns to the well?

    I think T is systemically more important than even it’s GM level valuation
    indicates ( which is huge)

    It will be such a shock if it implodes it may cause contagion.

    • R2D2
      Jun 18, 2018 at 11:16 pm

      You’ve got to admit Musk is a genius. His company is collapsing, all the signs are there, and yet he not only manages for Tesla’s stock price not to go down, but to go up; it is back to 370 now.

      I think we should turn Musk into a prophet; he can sell trash and empty promises to billions just like all the prophets before him. Give it a hundred years, and his religion will have a billion followers.

      I think I’ll prey to him starting from right now :).

      • Jun 19, 2018 at 6:00 am

        Or he could go into government ;)

  12. Paulo
    Jun 18, 2018 at 11:21 pm

    New tariffs against Chinese goods just announced….200 billion on top of the 50. China will match, maybe devalue their currency, and may also sell US Treasuries once they run out of tit for tats.

    Question for those crowing tonight about the strengthening greenback. (Not on Wolfstreet) How is this supposed to revive manufacturing and foreign sales of US produced export goods? Maybe Argentinian goods/products will compete quite nicely once they come to and start a re-set. Okay, tongue is lodged in cheek re: Argentina. But there are a whole bunch of other countries out there with declining currency values with a whole lot less debt than the US 106% to GDP.

    This sucker IS going down. How can it not?

    • ScottS71
      Jun 19, 2018 at 12:06 pm

      Great comment. Tariffs just killed the last bit of manufacturing in the steel, finished goods biz, as prices just increased; sending that overseas also.

  13. Desai
    Jun 19, 2018 at 1:55 am

    Wolf,
    I believe this article by former Reserve Bank of India(RBI) governor Raghuram Rajan published on 31 March, 2016 will shed light on stance of RBI:-

    https://www.project-syndicate.org/commentary/new-monetary-policy-rules-needed-by-raghuram-rajan-2016-03

    Apparently Rajan , then being current RBI governor, well knew that NIRP and ZIRP are not perpetual and had hoped to open a dialogue with Europe and US to minimize “spillover effect” of unconventional monetary policies of US and Europe.

    • Jun 19, 2018 at 7:39 am

      Raghuram Rajan did some good independent thinking during his time at the RBI. But he was encouraged by the government to move on.

      ZIRP, NIRP, and QE were explicitly designed to get consumers, businesses, and investors to abandon any idea of risk. They were designed to compress risk premiums to nearly nothing. And they did. The spillover effects were everywhere, from the US housing market to overproduction in the US shale space. One of those spillover effects was that risk premiums for EM investments were also compressed. This meant lots of cheap dollars for EMs.

      ZIRP, NIRP, and QE should have never been implemented. But just because they were terrible policies that should have never been implemented doesn’t mean they should then never be removed.

      EM’s welcomed and enjoyed the flood of dollars when they showed up. Now those dollars are getting a little more expensive. It’s not like this hasn’t been visible from day one.

      • sierra7
        Jun 19, 2018 at 8:52 am

        Bravo, Mr Wolf Richter!…..Nothing more needs to be said!
        Soon we can continue what should have been done in TGFC! (The Great financial crash)

  14. Jun 19, 2018 at 5:59 am

    High interest rates are supposed to reward investors for taking on high levels of risk. In reality, though, they increase that risk, because they worsen the circumstances of the borrower. The effect is to increase the interest cost of borrowers whose debt load is already excessive. Loco…

  15. Lee
    Jun 19, 2018 at 7:45 am

    I always think “this won’t end well”, but so far………

  16. Insta
    Jun 19, 2018 at 8:57 am

    From the 8th paragraph, I was not sure if this was a play on words or a typo…..”it downs on these geniuses”.

    Greatly appreciate your work Wolf.

    • Jun 19, 2018 at 9:26 am

      Unfortunately, it was just a typo :-]

      Thanks.

  17. KPL
    Jun 19, 2018 at 10:05 am

    IMO, as long as it is only the EMs that are affected and markets are still near their ATH, it is likely that the Fed will ask them to fend for themselves and will keep hiking. It is when the hike starts biting Europe, the EMs start affecting DMs and markets start falling that we will get to know the resolve of the Fed. It would get more serious if banks are affected. As of now, it all looks good for the Fed. Asian crisis, LTCM, housing crisis all started somewhere before it got serious and looked like taking the financial system down. That is the moment when the rubber hits the road.

    Let us wait and see.

  18. Ambrose Bierce
    Jun 19, 2018 at 11:00 am

    At 7% interest investors only need hold those 100 year bonds for 15 years to be made whole. The IMF is merely paying the dividends and allowing the sovereign to keep the principal which they need for investment. The Feds job is to set interest rates in a manner appropriate to risk in the markets, (stability) so 2008, they should have raised rates and now they would be lowering, ergo bond rates should be set out of regard to the interests of the buyer, not the seller. And you’re going to see bigger discounts (90 cents on the dollar is chump change, some 30yr TIPs have gone for 80 cents) going ahead because the size of the issuance is nothing compared to the global bond float under ZIRP. A lot of this low cost liquidity will be sloshing around for a long time. Eventually the Fed will drop the rate hikes, the more they insist they are sincere, the more they lie. The Fed has to crash the market in order to raise the risk premium in order to make their rates hike policy valid in order to inflate away massive government debt. Ctrl-Alt-Break. Meanwhile 100 year Argentine bonds at 7% will have a lower assumed risk when 30yr US treasuries are on a par.

    • Jun 19, 2018 at 2:31 pm

      So Ambrose Bierce, I understand what you’re getting at, but concerning your fist line, let me ask you a rhetorical question: how much risk are you willing to take to just get your money back after 15 years, without even inflation compensation?

      For that privilege, I’m willing to take zero risks. For me to take the risk in those bonds, I’d have to have reasonable assurance that…

      1. Argentina won’t default and stop paying interest before the 15 years are up.

      2. Argentina won’t default and impose a 70% haircut on bondholders.

      But both of these are fairly likely. 15 years is a long time in between defaults for Argentina :-]

      • Ambrose Bierce
        Jun 20, 2018 at 12:30 pm

        It’s also possible that Argentina is improving its economy (since the Falklands War) and that the risk level implied is excessive, and the rates attractive to buyers, who at least for the moment have an IMF backstop. They made a decent call if the discount was only ten cents and I think you will see discounts in US treasuries going ahead as we leave ZIRP and zero implied risk rates are going to rise. Considering the US geopolitical situation and its fractured electorate the prospects for a lower risk environment going ahead may lie elsewhere.

  19. chris Hauser
    Jun 19, 2018 at 11:29 am

    i wonder how the soybean and wheat piracies are doing in argentina.

    prices. hmmmmm. freudian autofill.

    is that a term or did i just invent it?

    never mind, googled it, old news.

  20. Bobby Dale
    Jun 19, 2018 at 1:36 pm

    When Argentina sold the 100 year bonds I visualized the seen from the first Star Wars movie when Luke Skywalker took out the Death Star.

  21. Justme
    Jun 19, 2018 at 3:38 pm

    About the so-called “Emerging Markets” (EM): Just 2-3 months ago Wall St and their psychophants on TV were spouting that we should all buy emerging market debt and stocks, and ESPECIALLY stocks.

    Now the EM stocks are being hit by a double whammy for US investors, namely falling stock price in the national currency AND a rapidly declining value of the EM national currencies that cause the USD-value of the stocks to drop even further.

    The exchange rate effect is not being brought up at all. I did some google searches and found very little relevant recent articles warning people about this effect. Only the sound of crickets in the background.

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