Get ready for yield curve controls…
If there was any lingering doubt that central banks have now become the central wind beneath the otherwise broken wings of the global markets, the latest signs of Fed yield curve controls will pretty much put this issue to bed.
In short, it’s time to bow our heads and toss a rose on the grave of natural market forces once and for all.
The Bond Market is the Thing
As we’ve made clear so many, many, many times in the bond category of our market report library, everything about stock behavior begins and ends with what happens in the credit markets.
Given the just staggering levels of corporate and sovereign debt in the US and around the globe, the only way to keep this grotesque game of musical debt chairs going long beyond its natural expiration date (i.e. implosion) is to keep the cost of that debt repressed.
As many already know, when bond yields rise, interest rates follow.
And as I’ve alluded, rising rates are to securities markets what shark fins are to surfers—really bad news.
“Solving” a Debt Crisis by Adding More Debt
Needless to say, the central banks of the world know this too, and thus in a dumb combination of both desperation and hubris, they’ve been struggling for years to artificially support low to negative interest rate policies to keep the debt bubble growing.
After all, if economies and markets can’t produce something called income (i.e. GDP), what’s wrong with piling on more debt to keep the party going?
Then again, the average 10-year-old knows that debt problems can’t be solved by more debt, they can merely be postponed.
So, drumroll the can-kicking, as it looks like the Fed is about to do even more long-term damage to the bond bubble markets in the form of yield curve controls.
What are Yield Curve Controls?
In a nutshell, yield curve controls are simply central banks printing trillions in more fiat currency to buy otherwise unwanted bonds to support their price and hence control their yields.
Unofficially, the Fed has been doing this for years.
Furthermore, we’ve already seen that same Fed bail out the junk and corporate bond markets in 2020 as the Fed made its first toe-dip into direct ETF purchases, an obvious sign that natural markets can’t even limp without central bank “accommodation.”
Yield curve controls use bond purchases to pin down yields on certain maturities to a specific target.
This, again, is an insult to natural price discovery and capitalist realism and, like unlimited QE, was once thought too extreme and dangerous to ever be used.
The Zombie Club Gets Bigger
But desperate times bring out desperate “solutions’—i.e. the dumb gets dumber.
For years, the Bank of Japan has been using yield curve controls, but then again Japan has been an economic zombie since the 1989 Nikkei crash.
Now, the US is about to join the Zombie club of half-dead economic growth and more “faking it” on a central bank zombie walk.
We warned of this in prior reports, and in particular, noted that Australia would head toward yield curve controls, which it has now begun as the land down under faces economic downturns.
Unofficially, the Fed and the Bank of England have yet to openly engage in yield curve controls, but don’t hold your breath: The dumb will get dumber.
As yield curve controls go global, investors will at least confess that the central banks are indeed the buyers of last resort and the fantasy peddlers of first resort.
First the Party, Then the Hangover
Initially, the yield curve controls will feel good. After all, more cheap debt always feels good—until the bill can’t be rolled over or repaid.
Furthermore, as central banks add more yield curve controls (i.e. low rate guarantees), the ravenous (i.e. dumb) appetite for more risk will rise, causing securities to get a little boost in the ironic backdrop of a global economic recession.
But hey, why should the markets or S&P CEO’s (paid by share prices) have to suffer even if just about every other citizen of the economic world is facing historical hardship and a $1200 check?
In short, yield curve controls will act as a temporary green light to buy just about everything the markets can throw at you, for the cost to borrow and buy is about to be mandated-low.
It’s more than likely that the Bank of England and the Fed will target lower-duration bonds and notes toward the zero to .1% bound, keeping the short end of the yield curve below the longer end—i.e. “faking the yield curve into submission.”
Another Front Run on the Horizon
Needless to say, such yield curve controls are also a signal to front run the short end of the yield curve, as those bonds are about to be overbought by central banks.
Of course, the flip side to such a front run is the fact that investors could sell off longer-dated maturities to buy the shorter dated notes, thus tanking prices on the 10-Year sovereigns and causing their yields to rise—perhaps dangerously so.
If the yield on the 10-Year Treasury, for example, were to rise too fast, that would be an “uh-oh” moment, as I’ve warned here as well as in our book, Rigged to Fail.
At that point, however, the Fed would likely buy more time by simply capping yields on the 10-Year or targeting a .50 yield on it—i.e. more faking it—i.e. more dumb.
Why So Dumb?
By using yield curve controls to repress yields and thus keep the debt party raging, investors will do dumber things, like over-borrow, over-leverage and over-pay for already over-valued bonds and stocks.
This is how dangerous market bubbles get even bigger and dumber—before they tank under their own weight.
Furthermore, with yields already stapled to the floor of history, investors seeking even a smidgeon of more yield will have to go further and further out on the risk branch to find it.
This means yield-thirsty and desperate investors, including broken pension funds, will take on more junk bond risk for meager reward—a dangerous set-up for an eventual fall.
As for now, the Fed’s Jay Powell hasn’t officially announced yield curve controls, saying only that “it remains an open question.”
Folks, that’s just Fed-speak for “here it comes.”
Remember: This rigged market is rigged to FAIL.
If buying more time seems worth the postponed failure, well, that’s up to each of you to decide upon and plan for.
Our Approach: Less Dumb, More Blunt
Our portfolio at Signals Matter is already prepared—both for the temporary bull run and the inevitable bear slide that yield curve controls will create.
In the short term, however, yield curve controls will be a massive steroid for more borrowing, Wall Street carry trades and corporate stock buy-backs to juice their EPS reports.
Additionally, lower rates via yield curve controls could help weaken the dollar, which is much needed for our dying export levels.
But the bottom line is this: Yield curve controls risk sending the now embarrassingly over-valued stock market bubble even higher in the midst of a recession, something I’ve never seen before and which makes me wince.
PE ratios in the stock market bubble are already the highest they’ve been in almost two decades.
At the same time, 9 of 25 developed markets are showing negative rates on their 10-Year sovereign bonds, which means global markets are running out of dumb policy options.
So, ask yourselves, does the market need more bubble support now? And do you think a bubble in a recession, even with Fed support, is a wise thing? A sustainable thing?
For us, the reward in the near-term is clear, but even more clear are the risks. And as most veteran portfolio managers know, money is made by managing risk not chasing bubbles.
As always, if such facts and risk management make sense to you, then join us HERE.