Rondonomics

Five years ago, ECB President Mario Draghi promised to do "whatever it takes" to save the Euro. In the midst of a sovereign debt crisis that roiled global financial markets, ECB action lived up to the rhetoric. Fueled by an extensive quantitative easing program, European bond prices surged and yields plunged into negative territory. However, in 2017 European growth and inflation finally started to accelerate higher, after years of anemic economic activity. In an era of uncomfortably high financial asset valuations - European bonds take the cake. Trillions of EUR denominated bonds trade at negative yields - investors pay borrowers to lend them money. These negative yielding bonds are not just government bonds but the debt obligations of corporations too. A few weeks ago, Veolia - a BBB rated water and waste treatment provider issued a 500mm EUR 3 year senior unsecured zero coupon bond priced to yield a negative interest rate at issuance! The European junk bond index yields l...

The flattening yield curve has sounded alarm bells in the bond market, raising fears of an increased possibility of recession in the near future. These fears are largely unfounded. When investors speak of a flattening yield curve they are referring to the tightening spread between short term and long term interest rates. Typically the spread between the 2 year treasury rate and the 10 year treasury rate (2s10s spread). A flattening yield curve may eventually become an inverted yield curve, implying the yield on short term rates will be greater than long term rates. This is a problem because it signifies the end of the short term debt cycle, a concept used by Bridgewater's Ray Dalio. The short term debt cycle involves the relationship between the growth rate of money and credit (or spending) versus the growth of the quantity of goods and services produced (capacity). Most spending is driven by increases in credit. For the private sector to generate credit growth, both borrowers and ...

In honor of the upcoming 19th National Congress of the Communist Party of China, I will highlight some of the significant hurdles the Communist Party faces that often go under appreciated in the western media. Like in many states - the largest risks to government rule are not external threats, but festering internal divisions. The challenges range from the financial system to geography and regional inequality. What is largely missed in the endless discussion over the global financial crisis and its aftermath, is that it was Chinese credit expansion that fueled the global economic recovery. In the face of a cratering global financial system, and the devastation to aggregate demand that would ensue, China unleashed fiscal stimulus - especially in its housing sector. Commodities prices and emerging markets soared in the years after the crisis, providing ballast for the world. In the exuberance, many industrial sectors became plagued with overcapacity, a problem China and the world must ...

"If something cannot go on forever, it will stop" - Herbert Stein Ten years ago this August, the French bank BNP Paribas froze three funds exposed to US subprime mortgages, an event many consider to be the beginning of the financial crisis. In "celebration" of the 10 year anniversary, I wanted to share some concerning observations from global fixed income markets: Since the beginning of the year, the yield curve has flattened  The 2s10s treasury spread went from 125 bps to 87 bps today The Fed dot plot implies 1 more 25 bp rate hike in 2017, and 3 more 25 bp rate hikes in 2018  That makes 100 bps over the next 16 months, the long end better go up.... Flattening yield curves usually precede recessions Global Debt is a 325% of GDP Corporate Debt levels are 30% higher today than in 2008 Corporate Debt to GDP is at its highest point in history NACM (National Association of Credit Management) have cited deteriorating credit conditions since 2014 The IMF re...

As the US recedes from the global stage as guarantor of world order, individual nations must fill the security vacuum and increase their own defense spending as various forces challenge global security in the years to come. After WWII, the forces of technology and globalization unleashed profound changes on global governance and economies. The Great Recession, income inequality, and erosion of trust in key institutions have poured fuel on the fires of nationalism and populism. Costly and ineffective wars in Iraq and Afghanistan have diminished American willingness and ability to project power abroad. These factors and events have hollowed out alliances that maintained peace among great powers during the post WWII era. To quote a report published by the Eurasia Group in September 2016:  "The end of governments' monopoly over politics isn't the only factor making the world messier. The very alliances that underpinned international relations in the post-World War II e...

The Fed recently eluded to the "normalization of its balance sheet" or quantitative tightening. The Fed has communicated this tightening will commence "relatively soon" potentially while short term interest rates are still in the hiking phase. I find this perplexing. The Fed's dual mandate is employment and inflation. Employment likely cannot go much lower, but the lack of significant wage pressures give comfort that the labor market is not overheating. Inflation is barely approaching the 2% target, and with the exception of a few years in the mid 2000s, has been at 2% or below since the early 1990s. Technology and globalization have smoothed out inter-regional economic links and muted inflation's effects in developed markets. If anything, growth expectations in the US have come down since the beginning of the year. One could even argue there is little justification for interest rate hikes in general (although this is not my opinion). The Fed has proven adep...

"The Germans make everything difficult, both for themselves and everyone else" - Goethe  The German economic machine has many admirers. They seem to operate in a beautiful fusion of capitalism and socialism resulting in a cohesive and productive society. Their European counterparts run unsustainable budget deficits, while Germany registers a capital surplus (greater than even China's). The southern periphery struggles with a rigid labor system; Germany's dynamism and highly touted apprenticeship programs churn out productive workers. Unemployment in Germany is under 4%, while in Greece it is over 23%. In the United States, the problem is not so much the lack of jobs but the lack of worker skills to fill open jobs. Many look to German training programs as a future model. In an age of blustering politicians who accomplish little, Angela Merkel is commended for holding the fabric of Europe together while taking tactical risks. She has navigated bailing out insolvent Eu...