By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Cross posted from Testosterone Pit.
The bond-fund massacre has been spectacular. Prime example: antsy investors yanked $7.7 billion in August out of the largest bond fund in the world, Pimco’s Total Return Fund. In July, they’d yanked out $7.5 billion, in June a record $14.5 billion. From May 1 through August 31, the fund’s assets shriveled 14%, from $292 billion to $251 billion; $26 billion from outflows and $15 billion from the shrinking value of the bonds. The fund lost 5.5% during that period.
By riding up the greatest bond bubble in the history of mankind, the fund has become known as a place where investors who don’t mind smaller returns but shudder at the thought of losing some of their principal could park their money without having to worry about it – but now, they’re worrying about it.
September is shaping up to be even worse. Bonds are cratering and yields are spiking worldwide. In the US, the 10-year Treasury yield kissed the magic 3.0% late Thursday, at least briefly, for the first time since July 2011, up from a low of 2.75% at the beginning of the month. It will drag other bond yields, mortgage rates, and other consumer and corporate rates behind it.
Pimco’s fund wasn’t alone: in total, $39.5 billion were yanked out of bond mutual funds in August, $21.1 billion in July, and a record of $69.1 billion in June. Emerging market funds, international bond funds… they’ve all gotten hit.
The Great Rotation out of bonds into stocks? Alas, that concept is vacillating between pipedream and deceptive hype, proffered by Wall Street for its own benefit. In reality, it doesn’t exist.
As bond-fund investors are pulling up their stakes, the hapless funds have to sell bonds, but for each bond they sell, there has to be a buyer, and for each dollar a fund receives for its bonds, there has to be a buyer willing to surrender it. It’s a zero-sum game. Um, plus the fees – because someone always makes money on Wall Street.
So the total number of bonds out there is constantly increasing as government and corporations issue new bonds and roll over maturing bonds, instead of paying them off with cash they’d put aside for that purpose (a concept that has become a quaint joke). This flood of new bonds must find buyers. Central banks have stepped in, with the Fed currently buying $85 billion a month, the Bank of Japan buying a lot, along with other central banks. In the end, there must be a buyer for every bond.
So there cannot be a rotation out of bonds. But there can be a rotation out of bond funds and into bonds pure and simple – and that is happening. It’s a painful process. As bond funds are forced to unwind their holdings, others step in to buy these bonds, at an ever lower price. This causes further bleeding in bond funds, more antsy investors who are yanking out their money, more force selling by bond funds….
It’s the unwinding of the “Wealth Effect” that the Greenspan Fed had pulled out of thin mountain air and incorporated into its unfounded belief system, and that the Bernanke Fed in its desperation elevated to a state religion, and a justification for printing $3 trillion, and that the Bank of Japan is now bandying about as part of its new religion.
They claim that inflating the values of bonds, stocks, real estate, farmland, MBS, no matter what kind of asset, by hook or crook, including forcing down interest rates to near zero and printing truckloads of money, will create “wealth” out of nothing, and that people who are thus “wealthy” will spend some of that “wealth” and crank up the real economy.
That religion hasn’t worked very well in the US – where the Fed is blowing $3 trillion on it. If it works at all, it only works for a limited time. Some individual investors, the lucky ones, can pull out their money and consume their gains, but investors as a whole cannot; because for each investor wanting to dump some assets, there has to be another willing to buy them. But they feel wealthier as they see their balance sheets or 401(k)s swell up. And so they might dip into their cash accounts or borrow against their inflated assets to buy some baubles.
Then the hangover sets in. Asset values cannot be inflated forever. Something has to give. Now bonds are sliding, taking down bond funds with them, and our antsy investors are dumping their shares, and bond funds are forced to sell more bonds just when other investors are reluctant to jump into the fray to buy them, and just when the Fed is contemplating pulling up its stakes too, and prices slide further. The giddy “wealth effect” that the Fed printed into existence evaporates, and people end up poorer, not only by the money that they thought they had and that they then spent, but also by the amount that their investments declined in value. It’s not an uplifting process. This is the wealth effect in reverse – the essential consequence of any wealth effect – and the Fed has wisely shrouded itself in silence on the topic.
“Bernanke’s maniacal money printing after the Lehman event catalyzed a virtual stampede back into the very same risk-asset classes which had been reduced to smoldering ruins,” David Stockman writes. It produced the craziest junk-bond binge of all times, allowing the mega-buyouts from before the crisis to survive and pay rich fees to the LBO lords.
Hard to see what the Fed can do about this. Yield chasers always get killed sooner or later. Perhaps we will see 5% Tbill yields again in my lifetime. I hope so. Its about time to stop punishing savers.
Interesting article, but overly Fed-centric and U.S.-centric IMO. Further, we have to date seen no material reductions in the Fed’s QE.
International capital flows — including reversal of European capital flight, ECB LTRO repatriation, the spike in US domestic oil production that is curtailing the volume of US dollars exported as the global reserve currency, and related carry trade reversals are also playing no small role in this matter IMO, although these factors are difficult to quantify without hard data.
I wonder whether this will trigger derivatives losses circa 2008 that could cause liquidity to evaporate and place systemically material institutions at risk?
In the mean time, this is having real world effects, especially in the area of municipal financing.
Too complicated. Stated more simply:
“As long as the roots are not severed, all is well. And all will be well in the garden.”
“There will be growth in the spring!”
He likes to watch.
And that’s what they get for feeding the financial economy at the expense of the real economy instead of supporting the real economy – ultimately the quality of financial assets is a function of the underlying real economic assets, and when the real economy sinks, sooner or later the financial economy sinks with it.
Supply-side theory says that enabling the financial economy to cannibalize the real economy enables the financial economy to support the real economy through the so-called trickle-down effect – which is contradictory, couldn’t happen, hasn’t happened, and won’t happen.
Fed policies for the last several years have done little more than enable the financial economy to continue the process of rent extraction for a while longer, solving nothing and delaying the inevitable. Those policies have been all about helping the parasites bleed the host and nothing about saving the host from the depredations of the parasites. It becomes clear why the real economy hasn’t recovered and won’t recover: the established policies prevent it.
Cannibalization of the Real Economy is exactly the right description of a process that has been going on since private banks were allowed to create debt but deregulation which allowed substantially increased leverage substantially enlarged the damage effect. Given that we now know through MMT that government could probably offer mortgages at something like 0.25% there remains no reason other than ignorance and political will why the cannibalization of the Real Economy should not now be substantially reduced in its effect.
Agree. Zirp here and in other countries as well. Makes me wonder why we seem to be helping the TBTFs get even bigger. If zirp is the policy going forward, which it should be because governments don’t need big banks anymore, what are those monsters going to do? I can’t even imagine the controlled demolition it will require to get rid of them. Turn them all into insurance companies?
The Chinese complained earlier yesterday that the US needed to cool their sorry selves and the 10y T yield spiked up to higher territory. They are also sending an “observer” warship to the area.
I think if China turns up the heat, Obama will have no choice but to back off.
China has the most leverage in the whole game through their treasury holdings. All it takes is them dumping a 100B or so onto the open market to bring everything to screeching halt. It will kill the US economy and force it into a recession possibly depression and at the same time if done right force down US government spending when they have no choice but to issue balanced Congressional Budgets to not take on any more debt to keep everyone from dumping treasuries when they lose confidence in the paper because everyone has determined the US government, including Nero Obama, are totally incompetent.
Not incompetent. Corrupt. They are actually very good at what they do.
Every system, every society, has to cope with a certain amount of corruption, and the resulting losses and inefficiencies due to corruption are inevitable and expected. Unfortunately it’s been well-established that those who cheat have an advantage over those who do not, so corruption has a natural tendency to increase. This situation requires mechanisms to keep corruption in check so as to prevent it from crossing a threshhold where corruption seriously compromises the system or destroys it.
The corruption of TPTB in the U.S. and the rest of the world roared past that threshhold years ago and never looked back. Prospects for a just, peaceful, and prosperous future are very much in doubt, if indeed they can be said to exist at all.
But look at the bright side. They’re bound to solve the global overpopulation problem. It won’t be pretty, but they will solve it. People will learn not to take things so very much for granted, and that can only be a good thing. It will be a truly excellent learning opportunity for anybody who manages to escape the debacle. The real concern here is that when it comes time to pick up the pieces that there are still some pieces left to pick up.
Ugly, and then weird ugly. Most people just can’t get their head around it.
I fear that nobody will learn anything from the coming catastrophe. The rich are preparing their “ranches” and “compounds” all through the intermountain West. They will retreat with their armed guards and ride out the crisis (or that’s their plan). They will emerge from the ruins with armed men and stockpiles of supplies, and the survivors will be so shell-shocked and weakened that they will bend to the will of their new masters or be gunned down in the road as examples for the rest.
It will be the modern American power structure divested of the Constitution and the rule of law. My guess is that my neck of the woods (New England) will avoid such neo-feudalism for a time, because it is remote from where the wealthy survivalist elite will congregate and has a long tradition of self-government. But when the need our farm land and water, they’ll come rolling in and likely gobble us up.
Your joking right? The Chinese are useless corporate controlled drones.
Yields can go higher, it makes little difference. Your lack of understanding economics shows.
We are just transitioning from the “Search For Yield” phase to the “Search For Bagholders” phase.
Same ‘Ole, Same ‘Ole – except Supersized with a sprinkle of $600 trillion of derivatives on top…..
It’s actually $1.6 quadrillion and increasing. It passed $600 trillion ten years ago and is now over twenty times the entire global economy, not ten times. TPTB downplayed the numbers so as not to frighten you.
It’s sooo hard to keep track…..
Curious to know where you are getting your numbers. This is from the BIS May report.
Am I missing something?
Certain categories of derivatives are not reported by BIS, and still others are not cleared through BIS. There’s no way to know just how big the number really is, but it’s expected that it grows a few trillion every month and never decreases unless there’s a major meltdown like in 2008, and possibly not even then. So the best guess is $1.6 quadrillion, plus or minus a couple of hundred trillion at the 95% confidence level. We’re 99% confident that it’s greater than 0.6 and less than 2.6 quadrillion. It’s extremely unlikely that it’s less than 600 trillion, and that’s the number that’s usually reported, presumably because it’s the least horrific.
I wasn’t kidding about planting potatoes yesterday. A couple of chickens could also be a good idea.
US growth has been 4-5% roughly over the last year. Stocks of course are moving higher, deceptive my backside.
In the 1980’s when interest rates were moving oddly, Alan Greenspan said we did not understand the global market. We did not understand that a culture of greed was inside the economy eventually acting like an unwanted weed. Massive money from overseas encouraged the mortgage take-over and basic crime of ignoring all mortgage laws within the states to grab a quick personal profit. Bond salesmen in all the cities and towns were doing well with “buy now and pay later”. We have a state-of-the-art animal shelter with volunteers due to inability to pay the bond interest and hire workers. Detroit pensions will be part of bankruptcy adjustment. California ruled pension payments will be “adjusted” in bankruptcy court. Municipal bonds are in the same bankruptcy packages now in court. Of course those investors will step back and say enough for now.
First of all, to put a canard to rest: there is no such thing as a ‘main street’ economy or real economy, that is no such thing as a real industrial economy at any sort of scale other than craft shops and ‘cottage industries’ … at scale industries cannot pay for themselves and must be entirely subsidized by debt.
That this is true is self-evident: if there was one self-supporting industrial activity anywhere on Planet Earth there would be no debts at all, they would be retired by deploying more of the beneficial machines. Instead, we deploy more machines and fall deeper into the debt abyss.
The fault is with the machines not with their management. We are long past the point where we humans can claw out of the
holegrave our precious toys and their masters have dug for us.
The consequence of non–productive industry is the increasing costs of debt, added to the increasing real costs of energy which powers the machines. The cost of inputs added to the cost of debt needed to put the inputs to ‘work’ … minus the returns on the work itself must equal zero. This is not magic rather it is bookkeeping: income vs expenses.
Richter does not go far enough: for every seller (of consumer junk) there must be a buyer with borrowed money in hand. Our ‘work’ is nothing but resource waste, there is no return — real or otherwise — to it. Without the ability to borrow there are no ‘returns’ at all … only the aggregated costs of inputs and debt becoming enormous.
These amounts are enormous, indeed; they discredit the establishment that has taken them on. How does a quadrillion dollars in swap claims fit within the average wage-earner’s repayment capacity, again?
Wolf Richter is an ex-car salesman, that is his ‘entrepreneurial background’. He never mentions energy … ever … or its costs; he never mentions energy waste, he never mentions the Black Hole in the center of our economic galaxy: the absence of return on the world’s greatest industry and its dependencies; he never mentions the ongoing rush to cannibalize what remains of usable resources … our last frantic greedy lunge … into war, ruin, debt collapse … perhaps human extinction. So we might drive to work and pretend we are rich.
The wealth effect …
That which is “self-evidently true,” usually isn’t.
>>> First of all, to put a canard to rest: there is no such thing as a ‘main street’ economy or real economy, that is no such thing as a real industrial economy at any sort of scale other than craft shops and ‘cottage industries’ … at scale industries cannot pay for themselves and must be entirely subsidized by debt. <<>> The consequence of non–productive industry is the increasing costs of debt, added to the increasing real costs of energy which powers the machines. The cost of inputs added to the cost of debt needed to put the inputs to ‘work’ … minus the returns on the work itself must equal zero. This is not magic rather it is bookkeeping: income vs expenses. <<>> These amounts are enormous, indeed; they discredit the establishment that has taken them on. How does a quadrillion dollars in swap claims fit within the average wage-earner’s repayment capacity, again? <<<
First of all, I remain skeptical of the 1.6 quadrillion figure, and have not been impressed with how that figure is produced, or even it it's all together that relevant. But even if we allow this figure, this is actually the critical point heterodox economists are trying to make. The dominant position is that giving vast sums of money to the –sic- wealth creators ( 0.0) will some how trickle down to the lower casts, doesn’t work. Capital remains at the top, and even more importantly, doesn't correspond to real wealth – just their narrow definition of wealth that just happened to be measurable in dollars.
“So the total number of bonds out there is constantly increasing as government and corporations issue new bonds and roll over maturing bonds, instead of paying them off with cash they’d put aside for that purpose (a concept that has become a quaint joke).”
Actually, rather than a quaint joke, it’s a Ponzi scheme. And we know how they end, without exception.