Seldom does the enormous bond market turn on the fate
of a single trader. Well, the news that Bill Gross was leaving Pimco under suspicious circumstances did not go unnoticed.
The WSJ writes:
“The
yield on the 10-year benchmark Treasury note was hovering around 2.506% immediately before the disclosure that Mr. Gross was
leaving the hundreds-of-billions of dollars in Treasurys and other debt he oversaw at Pimco to go to rival firm Janus Capital
Group Inc.
Within
a half-hour, the yield jumped to 2.546%. While a move of 0.04 percentage point may not seem like much in
that period of time, it was perceptible enough in the $12 trillion Treasury market that several traders and strategists attributed
it to the news about Mr. Gross.”
Attempting
to explain the reasons for his departure, The Economist speculates in the essay, Overthrowing the Bond King. “There appear to be three main reasons behind Mr Gross’s abrupt exit. The immediate cause was his abrasive management
style . . . Moreover, Mr. Gross’s public behavior has grown increasingly peculiar of late . . . Such mis-steps might
have been forgiven had Mr. Gross’s charmed streak as an investor continued. But over the past three years, several misjudgments
have caused his funds to lag.”
At
this point What You Need to Know About SEC’s Investigation of Pimco, centers on a relatively small $3.6 billion ETF, exchange-traded fund.
“Apparently, Pimco went around buying up small blocks of bonds, known as
“odd lots,” at discounts. Pimco then marked their prices upwards using estimates of their values derived from
larger blocks of bonds.
If Pimco really couldn’t resell the bonds at the new, higher prices it seems off base. But it also seems plausible
the bonds might genuinely be worth more in Pimco’s hands than they were in the hands of whoever sold them.”
The mystic that Pimco enjoyed in bond trading may
have sunk from the implications of SEC snooping. Gross seems like he is sprinting for the exit, but is this all that is in
play? Investor’s Business Daily paints a smiley face on the open door that Gross' transfer of loyalties as a positive for Janus Capital Group.
Now step back from these headlines and examine the
concerns that have been floated about the bond market for a very long time. Money Beat in an account suggests that a Bond Bubble Will Burst in a ‘Very Bad Way’ and reports on the recent Bloomberg’s Markets Most Influential Summit.
“Bonds are at ridiculous levels,” Julian Robertson, founder of one
of the earliest hedge funds in Tiger Management Corp., said on a panel at the Bloomberg Markets Most Influential Summit. “It’s
a world-wide phenomenon that governments are buying bonds to keep their countries moving along economically.”
Howard Marks, the chairman
of Oaktree Capital Group LLC, said interest rates are “unnaturally low today.” Leon Cooperman, founder of Omega
Advisors Inc. and former partner at Goldman Sachs, said bonds are “very overvalued.”
Forecasting the direction of government bonds usually focuses on predicting what
central banks will do to drive interest rates, either up or down. Since consensus in market watchers has long announced that
U.S. Bonds yields are unnaturally low, the calls for a turn upward in interest rates seem ridiculously overdue in coming.
All that seems reasonable; however, the Federal Reserve
is playing a much different game from the responding to the normal business cycle.
Since the financial meltdown of 2008-2009, the charts and metric gauges for predicting
market movements require a complete overhaul. Betting on U.S. Bonds no longer is based solely on domestic factors.
ZeroHedge cites David Tepper Is Back, Sees "Beginning Of The End" Of Bond Bubble.
“Empirically,
Tepper may be right: in the past every time a central bank has launched a massive easing program (think QE1, QE2, Twist, QE3,
etc.) it resulted in aggressive stock buying offset by bond selling. The issue is when said programs came to an end, and led
to major selloffs in equities, pushing bonds to newer and lower record low yields. So perhaps for the time being, we may have
seen the lows in the 10Year and in the periphery. The question is what happens when Europe's latest "Private QE"
operation comes to an end: just how massive will the bond bid be when all the money currently invested in risk assets decided
to shift out all in one move.
More importantly, it also explains why central banks now have to work in a constant, staggered basis when easing,
as the global capital markets simply cannot exist in a world in which every single central bank stops cold turkey with the
"market" manipulation and/or liquidity injections.”
Within this context, why all the hullabaloo over Bill Gross jumping ship? While price inflation is real
and grossly underreported, currency deflation still persists over the last six years. Now some may claim this phenomenon proves
that stability in the bond market exists. Conversely, if this measure is acceptable to institutional bondholders, are they
not accepting very low returns out of fear that the economy still hangs on a precipice.
Always remember that bonds are loans that have an obligation for repayment. Stability
is maintained in the core indebtedness with the reimbursement settlement of the principal. Most governments are able to string
along the unavoidable roll over so that new funds are raised to refinance.
Not so in every case from private or corporate debt. Just ask the bond holders from GM, better
known as “Government Motors”.
Government
bonds make up the essential float in the paper trade. As long as the global collateralization of bonds is honored, the planet
may be able to avoid the fate of Greece. Pimco is but a pimple when compared to the Federal Reserve’s monetization of
U.S. Treasury debt.
Bond professional
traders look for an edge. Firms may risk their own capital, but most brokers look to skim an easy commission. It’s the
institutions who have the most at stake and need a stable bond market. When not if, the bubble busts or deflates, the air
is going to escape and blow over average investors.
James Hall – October 1, 2014
