With every passing day, negative 10Y yields across the developed world's bond market, and not just Switzerland, increasingly appear to be a question of when not if. Paradoxically, the main reason for this long-end deflationary crunch will be an action that the ECB will undertake in three days that is designed to spur inflation, and yet what it will achieve is to send the most deflationary signal possible: a global bond market in which bondholders pay sovereign issuers to issue debt.
Needless to say this is precisely the opposite of what central banks should be doing in their quest to (hyper)inflate away debt.
And the clearest indication of precisely what the ECB will do the inventory of available global G3 (US+European & UK+Japanese) collateral, is the following chart from Credit Suisse.
As the Swiss bank explains, "Despite the Fed ending its purchase programme, an ECB sovereign QE would reduce the available share of G3+ sovereign duration (Treasuries, Gilts, JGBs and European Government Debt) for the market to an all-time low. The ECB has the potential to take out up to 5% of G3+ duration of the market if it embarks on a €1 trillion programme. This could keep interest rates globally at very low levels despite a potential Fed policy tightening in 2015 – particularly in the longer end."
The share of duration outstanding in USTs should rise back towards mid-2012 levels, while the ECB could substantially eat into the available EUR duration (see Exhibit 3). Considering duration differentials in a vacuum, one might assume that US government issues should underperform their European and Japanese counterparts.
What this means for stocks is unclear now that virtually every metric is screaming record overbought territory, especially with GAAP EPS in 2014 down from 2013, and - assuming the crude collapse persists - 2015 earnings will be far lower than 2014. However, there is little debate in what it means for bonds:
... the chances of an extension in the search for yield trade could see this [UST/Bund] spread move toward 110bps, suggesting a test of the 1.60% level in 10-year Treasury yields, which was the lower end of the 2012-2013 range.
Congratulations ECB: in your attempt to spur inflation you are about to unleash the most deflationary signal the financial world has ever seen: global NIRP.
And yes, for those wondering, the inevitable conclusion of this silly game is what we said would happen from day one back in March 2009: the central banks, who can create both electronic and paper money with a key stroke, will do just that, and then - as Bernanke conveniently predicted - literally paradrop it ouf of a helicopter, in their last ditch effort to prevent a global deflationary implosion.
This too is no longer a question of if, but when.
