Albert Edwards has copped a lot of criticism over the years for being too bearish on stocks. However, as we’ve noted before, the Societe Generale strategist has been equally stubbornly correct about one very important point which most others have got entirely wrong. He’s been a bond bull through thick and thin.
So that’s why we were really interested to read his latest report. Because now he thinks the bond bull could be very close to ending.
Politicians are embracing money printing even faster than you’d expect
Albert Edwards’ view has always been that we are in an economic “Ice Age” of stubbornly deflationary, stagnationary forces. Under this thesis, it made logical sense that US bond yields would eventually join those of all the other big economies in negative territory. (Remember – when bond prices rise, yields fall, and the other way around). And so far, that’s what has happened during the coronavirus crisis.
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However, he has also pointed out that the next recession would be such a massive deflationary bust that it would result in an equal and opposite reaction from the public sector, driven by voter anger and economic chaos.
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It would probably involve governments piling in with the aid of central banks and printing as much money as it takes to bail entire economies out. The shorthand for this is “helicopter money”. This would eventually turn around the slide in bond yields and result in inflation.
This, of course, is what we’ve already seen as a response from governments. And this turnaround has been so rapid that Edwards reckons we might be closer to the denouement than he’d expected. “The size and synchronisation of the fiscal and monetary stimulus represents a sea change in policy aggression… policy is transitioning to helicopter money”.
You can see it happening across the board. Politicians are planning to hand out money to citizens in the US – the initial package probably isn’t enough but there will be more where that came from. In the UK, the Bank of England yesterday went all out to ensure small and medium-sized businesses can get their hands on loans, while the chancellor is coming up with plans for protecting wages.
Even the European Union, led by Germany, is starting to look as though it might consider issuing joint government debt to tackle the crisis (we’ll see if that happens).
All of this has helped us to see an “up” day for markets so far, although it remains to be seen how long that lasts. But the intervention of governments is everywhere now — even crude oil prices have rebounded from an 18-year low on news that the US plans to buy up oil from domestic producers for its strategic reserve.
The US Department of Energy will buy the oil from small and medium-sized US producers. It so far plans to buy 77 million barrels. There’s also talk of acting to get both Saudi Arabia and Russia to stop producing as much, although it’s clear that Donald Trump wants to strike a balance between helping domestic producers and keeping petrol prices low for voters in November.
It appears that we crossed the political threshold for doing “whatever it takes” a long time ago. It’s not about the will to do it anymore (which was very much the post-2009 fight). It’s now about ironing out the practicalities (which will be difficult enough).
In short, this is happening faster than Edwards expected, and that has implications for just how bad this all gets.
The economic news is going to get a lot worse over the coming months
So what does it mean? Well, the problem is that the financial system went into this in a very fragile state. In effect, we’ve had a “just-in-time” financial system operating with no real margin of safety (bar a reliance on the Federal Reserve as the ultimate safety net). Like every other aspect of our “just-in-time” economy, this has been brought to a shattering halt by the coronavirus and our response to it.
So while “whatever it takes” and helicopter money will eventually “trigger a recovery… we collectively have no idea how deep this economic and financial market meltdown will be”.
As a result, the bond bulls may still have one last hurrah. As Edwards notes, markets are likely to panic when they see how bad the upcoming economic data is going to be. That makes sense to me.
Yesterday, new weekly jobless claims in the US surged to 281,000 after sitting around the 210,000 mark for the best part of the last two years. That’s a shocker, and it’s happening at a time when the economic downturn and the shutdowns have barely started. To put it bluntly, the data for the next few months is going to be nothing short of horrific.
As a result, Edwards says, we could well see new lows for bond yields, “with the US ten-year converging with Bund [German government bond] yields deep into negative territory.”
However, it’s possible that we won’t get that far. And as Edwards reiterates, the arrival of the helicopters almost certainly means that this recession will mark the end of the Ice Age. So he’s “keeping an open mind”.
But the overall point here is that this is the turning point. The biggest secular trend of most of our investing lifetimes – the long-term decline in interest rates and inflation that started in the early 1980s – is now in the process of ending. Whatever comes next, it’s going to have a profound impact on all of our portfolios.
We’ll be discussing this in a lot more detail in next week's issue of MoneyWeek – and we’ve got helicopter money on the cover of this week’s issue, out today.
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