Blain’s Morning Porridge Oct 19th 2022 – In Bonds There Is Truth, But Don’t Expect Central Banks to Pivot Early
“If the answer is Jeremy Hunt, it must have been a really stupid question.”

This Morning:. In Bonds There is Truth – but until Real bond yields turn positive they remain financially repressive. If Central Banks “pivot” from tightening rates to address inflation too early, markets will remain fundamentally distorted.
What’s wrong with markets today… ?

I always tell readers: In Bonds There is Truth… or at least there once was.. back in the mythical free-market Camelot of 1980-2008…
Government Bonds, be they Treasuries, Gilts, JGBs or Bunds set the “risk-free rate” from which all other investments are set. Because Gilts will always repay at Par, they set the rate from which businesses in the UK set their investment expectations, and investors determine the risks of other investments and what their book should look like in accordance with their risk appetite.

The risk-free rate is the base line for everything in markets.
As we have discovered… play with the risk-free rate at your peril. It has triggered multiple consequences across the economy. 14 years of monetary experimentation and risk-free interest rate distortion enabled the everything rally in bonds, stocks and every other asset class you can think of.
Finally, the everything rally is unravelling, shaking the whole edifice of society, and predictably the market does not like it.

By distorting interest rates, the whole basis of investment was changed. Rather than analysing real world economic and business risks, investors began to front-run Central Banks juicing markets with artificially low rates. As bond rates fell, to secure returns investors were forced to either travel down the risk curve to take larger risks, or to use leverage to magnify returns.
Now that QE is over and quantitative tightening has begun (pulling money out the market as rates rise) markets have become uncertain – going back to value fundamentals. On the back of multiple crises, including energy and inflation, volatility has increased. This is when the problems really begin. As leverage and volatility bite, it becomes impossible to exit illiquid markets. That was basically what yesterday’s Porridge was all about.
We know that to address inflation aggressively Central Banks have to institute a controlled economic slowdown. That’s the equivalent of landing a Superjumbo on a very short Himalayan airstrip (mountain at one end, cliff at the other) with 1 engine and no undercarriage… in the dark, without crashing.
Now, there is now a dangerous belief in the Bond market developing that it will impossible for Central Banks to raise interest rates much higher. They expect a Fed Put will stem market losses.
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