Economic stability, according to post-Keynesian economist Hyman Minsky, encourages more risk taking and higher leverage -- ultimately causing speculative bubbles and painful recessions. Government intervention designed to stabilize or stimulate the economy, such as quantitative easing (QE), is destabilizing when it gives markets a false sense of confidence. When false confidence is high, Minsky noted, markets become dominated by Ponzi buying -- when investors ignore fundamental asset values and nevertheless borrow to buy, based purely on the belief they can sell assets for more tomorrow than they paid today.
The U.S. Treasuries market could now be described as a Ponzi market. The only reason investors would buy Treasuries today is that they expect the Federal Reserve will buy them at higher prices in the future. This reasoning will come unstuck, however, once the Fed curtails its asset purchase program. We do not know when the Fed will taper QE, but the longer its expansionary policy continues, the more volatility-inducing pressure will build. That means stock and bond markets appear to be in for a rough ride over the next six months or so.
Historically, the real yield on 10-year Treasuries has closely tracked the University of Michigan Consumer Sentiment Index. The correlation broke down, however, in 4Q2011, as a result of the Federal Reserve’s asset purchase program. The yield on 10-year Treasuries would be roughly 150 basis points higher than it is today if the market was not being distorted by Ponzi (uneconomic) buying.
UNIVERSITY OF MICHIGAN CONSUMER CONFIDENCE VS. REAL 10-YEAR TREASURY YIELD*
Source: Bloomberg, Haver Analytics, Guggenheim Investments. Data as of 5/31/2013. *Note: Real 10-year yield calculated by using nominal 10-year yield and core PCE inflation.
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While the market will remain volatile and likely lead to a period of outright panic, that is when having a “cool head” will pay off.
The adoption of negative interest rates will do little to stimulate growth.
While spreads have since narrowed, we are still finding bargains in high-yield bonds and bank loans.
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