Negative rates are always and everywhere a Bad Thing

Outlook:

In a jittery but rangey market, it can be hard to keep perspective. We continue to worry about low and falling rates of return on capital, not to mention negative rates. Yesterday the UK issued a 20-year bond for £1.5 billion at a yield of 1.64%, a record low yield for a new issue. The last comparable was 2.11% in May. The bid-to-over was a weak 1.5. The FT notes that "In the secondary market, the 20-year gilt yield plunged from 2.09 per cent on the day of the referendum to a record low 1.40 per cent at the start of July."

The UK is far from going negative but, depending on developments, may end up there. Negative rates are always and everywhere a Bad Thing. Just ask Mr. Draghi. It was long forecasted that the ECB would run out of qualifying paper to buy. The FT reports Tradeweb estimates "just under €1tn of eurozone debt is now ineligible for the ECB's QE programme, since its yield is less than the central bank's limit of minus 0.4 per cent. This represents 17.5 per cent of the entire market for eurozone debt."

Well, under 20% is hardly cause for alarm—is it? Still, you have to wonder how a currency with falling yields and a historic low yield on a new issue (GBP) can rally a day later? How can the euro be holding up over 1.1000 when the central bank is (probably) about to go more deeply negative in the next few months and may need to change its rules on eligibility to keep the merry-go-round spinning?

There are more questions in here: how can central banks "manage" the financial sector in what seems like a permanently low or negative yield world? The answer is that they are working with spit and duct tape. Institutional failures must be in the pipeline. We can hope the central banks can see them coming, but what are their options?

We should all be very worried—and yet risk appetite seems okay, mostly, and gold is not screaming.
See the gold chart—to the degree we consider gold a proxy for risk aversion, worry is low. We see the same thing with VIX, another proxy for risk aversion. After a spike on Brexit to 25.76, VIX is quoted at 12.06 this morning. It was a near one-year low of 11.97 on Tuesday.

Here's another puzzle—Venezuela is a failed state. Turkey just had a failed coup and has declared a state of emergency, but yield-starved investors are still pouring cash into emerging markets.

The perspective makes you dizzy. All these things should not be true at the same time. Prices are defying conventional risk assessments, especially of a political nature. In fact, politicians are failing everywhere and not only in emerging markets. We can say Cameron's call for the Brexit referendum was a mistake. We can say the EC's response to refugees has been a mistake. We can even say the Republican party made a mistake underestimating the voters' disgust at their do-nothing performance, leading to Trump (of all things).

But market players really don't like political analysis, and it's not hard to see why. Much of it is so ideologically addled that you can't tell truth from fiction. Besides, equities are rallying pretty much everywhere and to many, that's all that counts. To hell with arcane stuff like yields. Only about five people understand the bond market, anyway. The commodity gang is not exactly famous for clear thinking, either—jumping up and jumping down on the slightest of whims.

So, when it comes to currencies, the best we can is admit that traders are no better at evaluating political risk than traders in other sectors, and they are taking and adjusting positions without a game plan. An economist may say the pound and euro should fall, and the chart may indicate the same thing, but give ‘em a juicy headline and watch the market go the other way. It's a game of pick-up-the-pieces now. You have been warned. We may not get a crisis but the conditions are in place for a crisis to occur.

Political Tidbit: The guy who wants to run the country can't run a convention. Mismanagement abounds, not least letting Cruz up on the stage. This is probably on a par with the Clint Eastwood empty chair ramble. But the best tidbit of all is the report that Trump's minion offered the VP job to Kasich, who is sane and reasonable if utterly without charm, saying as VP he would be in charge of domestic and foreign policy. Kasich asked what would the president do if the vice-president is in charge of everything? The answer was "make America great again." This seems to mean the president would be huckster-in-chief. But the convention's public relations are a disaster, so far.