Registered Investment Adviser Caleb Lawrence
Another volatile early session sent the major averages into the final hour about even on mixed data. 2nd Quarter productivity advanced 1.5%, unit labor costs increased just .2%. While an improvement over the first quarter the trend remains weak as it has done for 3-decades.
I have said repeatedly that Japan is the proverbial Canary in the coal mine with respect to debt, credit busts and deflation, following their 1991 debacle that continues to this day. Recent monetary and fiscal policies in Japan have led to considerable government purchases of both bonds and stocks using essentially printed money. All sorts of dire predictions were made when this path was originally chosen and Abenomics as it was called at the time, after the prime minister Shinzo Abe, was widely viewed as a failure. Fast forward to the present and the International Monetary Fund or IMF figures that through the magic of negative interest where bond holders pay the issuer, meaning the government of Japan in this case, interest on the bonds they buy will not only stabilize debt to GDP or Gross Domestic Product ratios they will actually fall a handful of points to 232% of GDP by 2022. Usually the bond holders receive interest from the issuer, and if you’re thinking that it is a little odd that the government is both the buyer and seller, your right it is. The government made other changes as well including reducing pension payments and raising taxes, but that still leaves the conundrum of negative yield bonds. I can think of very, very few reasons, if any at all, why a sensible private investor would purchase a negative yielding bond. Not only would they have to pay interest to the issuer but the bond would also come with substantial credit risk should yields normalize or increase. It is currently estimated that about 20% of global government debt features a negative yield. Additionally, central banks are thought to be price insensitive when it comes to purchasing bonds as this technique is used to sterilize cash and keep it from flooding the economy and creating rampant inflation, or at least that’s the theory anyway. If you’re wondering how this works in the real world, to be honest, so am I. Welcome to modern engineered finance, where debt is irrelevant, nothing matters, there are no negative consequences and the trend is your friend, until of course one day it isn’t. I fear that when that day comes there will be hell to pay.