(Bloomberg Opinion) -- The way the global government bond market is acting, it looks as if the highly controversial Modern Monetary Theory is about to be put to the test. In essence, the theory suggests that countries with their own central banks need not worry about budget deficits and spending to spur economic growth because those central banks could just buy whatever debt the government issues.
What makes MMT relevant now is that despite continuing jitters over the global financial system and another plunge in equities on Wednesday, government bonds from the U.S. to Germany, and from Italy to Australia, tumbled, sending their long-term yields soaring and causing yield curves to widen. This is hardly the reaction that would be expected in a “risk off” environment when the safest assets such as government debt should be in demand. Some might argue that the bond market is just discounting the possibility of runway inflation once the economy recovers because of all the fiscal stimulus programs — including ones that may total close to $2 trillion in the U.S. alone — that will need to be financed with debt. But so-called breakeven rates on bonds have held steady, or even declined, suggesting traders see no inflation on the horizon. That leaves worries about who will buy all the debt that will be issued. It’s hard to know how much is coming, but “Bond King” Jeffrey Gundlach said Tuesday in a webcast that the U.S. budget deficit may triple to $3 trillion. That’s a scary thought for bond traders in a country whose debt has already ballooned to $23.4 trillion from less than $10 trillion before the 2008-2009 financial crisis.
This is not just a U.S. problem. Globally, debt surged to a record $253 trillion at the end of the third quarter, or 322% of worldwide gross domestic product, which is also an all-time high, according to the latest data from the Institute of International Finance. “The combination of ballooning Treasury issuance needs and the eventual return of inflationary ambitions bode well for the longevity of the move” higher in yields, the top-ranked rates strategists at BMO Capital Markets wrote in a research note Wednesday. Yes, yields are still low on an absolute basis, but history shows that can change quickly. Anyone remember the late 1970s?
GET ME OUTTA HERE!There is another plausible theory for what is happening in the markets, with the historic volatility and even haven assets such as government bonds selling off along with riskier assets such as stocks. That theory says we are now in the phase of the crisis where investors are selling anything they own that is liquid to meet margin calls. “Risk assets are simply being liquidated globally as overvaluation and leverage do what they always do: force participants to generate cash,” the strategists at Cantor Fitzgerald wrote in a research note. “If you are levered long in an equity position and that equity position loses value, you must liquidate other assets in order to generate cash to satisfy your margin call.” Pretty simple, but it’s one of those things that nobody in markets can accurately predict will end given the lack of data. The synchronized drop across major assets is not something that’s supposed to happen, and is a threat to classic diversification strategies, as Bloomberg News’s Sam Potter notes.
DOLLAR DANGEROne thing that’s not falling is the dollar, which is concerning. The Bloomberg Dollar Spot Index reached a record high Wednesday, having risen about 7.5% since March 9. The last time the gauge experienced such a swift move higher was during the height of the financial crisis in late 2008, showing the extent of the dash for dollars globally. Of course, the rising dollar does U.S. exporters no favors, but the real problem is in emerging markets. Issuers in developing countries have borrowed trillions of dollar-denominated debt, and the greenback’s rise means it’s much more expensive for them to make interest payments or refinance. The Institute of International Finance estimates that emerging-market borrowers have $8.3 trillion of foreign-currency debt, most of it in dollars, up by more than $4 trillion from a decade ago. Cumulative investment outflows from emerging markets since January “have surpassed the levels observed at the peak of the global financial crisis and are an order of magnitude larger relative to the size of the global economy” than prior periods of stress, the IIF says. “Based on these past global shocks, we can expect reserve losses and substantial current account adjustment across EM as financing dries up.” It’s no wonder the Bloomberg Barclays Emerging Markets Hard Currency Aggregate Index is down about 10% this month, compared with 2.89% for the global bond market overall.
OIL’S VIRTUAL STIMULUSThe price of oil cratered again on Wednesday, with West Texas Intermediate falling as much as $6.89, or 25.6%, to $20.06 a barrel. It’s now down 66.5% since early January. The latest leg lower came as Saudi Arabia vowed to keep producing at a record “over the coming months,” doubling down on its price war with Russia. On the downside, these low oil prices are putting tremendous pressure on frackers and other drillers, whose business models depend on much higher prices. This is one reason the junk bond market is so weak, as many of these companies have issued tens of billions of dollars in debt to fund their operations. On the upside, the low oil prices are a boon to energy users. But like so much in markets these days, even the upside has a downside. Airlines should benefit but can’t as they ground planes while travelers cancel their plans. JetBlue Airways Corp.’s average daily sales have plummeted 82% this month. Also, regular-grade gasoline prices as measured by the Automobile Association of America have fallen to $2.217 a gallon from this year’s high of $2.600 in early January. Citigroup’s economists estimated in a research note that lower gasoline prices may add as much as $125 billion in extra disposable income to consumer wallets. But with the spreading coronavirus keeping Americans close to home, such a potential boon looks more like a lost opportunity.
TEA LEAVESIn normal times, the weekly report on jobless claims put out by the U.S. Labor Departments merits little more than a footnote. But these are clearly not normal times, and the next report due Thursday is likely to get much more attention than usual as it will provide the first real-time reading on how the spreading coronavirus is impacting the economy. Economists have no idea what to expect, which is why the median estimate in a Bloomberg News survey is for a reading of 220,000 for the period ended March 14, up only slightly from 211,000 last week. Anecdotal evidence suggests the number could be much higher. In Connecticut, about 30,000 claims have been filed since Friday, about 10 times the average weekly total, according to Bloomberg News’s Reade Pickert, citing the Hartford Courant. Ohio received more than 48,000 applications the past two days, compared with just less than 2,000 for the same period the week before, Columbus television station WBNS reported Tuesday. New York had an “unprecedented” increase in phone calls and web traffic for unemployment insurance claims and advertised on Twitter more than 50 job positions for immediate hire in the last 24 hours to help process the huge inflow of claims, Pickert reports.
DON’T MISS Stocks Are Not Yet a Bargain, Even With the Rout: Nir Kaissar Why Are Real U.S. Yields Suddenly So High?: Brian Chappatta Dollar Funding Is Freezing Up, and the Fed Knows It: Shuli Ren Cheap Sterling Has Reasons to Be Cheaper: Marcus Ashworth Worries Ease About Economic Response to Virus: Mohamed El-Erian
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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