German bond yields crash below JGBs, “Japanization” of Europe



I hear a distant whisper of the word “deflation” as I scratch my weary chin and stare deeply at a small, nearby flame. The electrical fuse for my study has blown out from the recent blizzards in New England, and luckily, my ex-girlfriend enjoyed enormous, numbered candles on her birthday cakes. Did I just imagine the distant voice describing European deflation in my head? Probably. Does that mean it’s not true? Absolutely not.

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The temporary inconvenience brought on by the winter weather is an ideal opportunity for me to practice Trāṭaka, (त्राटक), which in Sanskrit is the practice of staring at a single point—such as a small object or candle flame—as a way of developing one’s level of concentration. At this point, I wish I had a quill pen to chew on as I pontificate. Just kidding; I’m neither wise enough nor cool enough to enjoy this current state of affairs. The candle could very well be a halogen lamp, for all I care. If only I were paid enough to pontificate…

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Back to the real world…this is Market Realist, after all.

Is Europe the new Japan?

Yesterday, yields on German 10-year bonds fell as low as 0.305%, while Japanese 10-year yields rose as high as 0.358%. If your mouth is gaping wide open in amazement right now, relax your jaws a bit until after you read the following point: The yield on the 10-year Swiss bond just reached -0.322%!

It almost sounds like we are making this up as we go along, but sadly, the data is all true. The new, 1.1-trillion euro QE (quantitative easing) plan of the ECB (European Central Bank) and recent deflationary readings have propelled many regional European yields to negative levels. According to Eurostat, consumer prices have fallen 0.6% in Europe this year, signalling that inflation will be well below the government’s 2.0% target for the foreseeable future.

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Is this a good thing? It could be positive for EU asset prices, as we saw with the US five-year quantitative easing experiment. However, for individual borrowers and the middle class, the European version of QE could be even worse than ours. In fact, Swedbank (Sweden) just commented that “negative rates could trigger lending contraction” in response to bets that Sweden’s central bank will lower its repo rate below 0%. So, would QE actually decrease lending in a negative rate environment? US Treasury Secretary Timothy Geithner complained for years about how the lack of US bank lending was holding back the recovery during QE, but that was only a lending slowdown with 0% rates. What if outstanding loans in Europe were actually to fall materially in a negative rate environment?

While Europe was reacting to its new easing policy yesterday, JGB (Japanese government bond) yields rose sharply after a local bond auction could not attract enough investors. The fall in price of these bonds after the failed auction was the largest in the last two years.

Prime Minister Shinzo Abe and central bank president Haruhiko Kuroda immediately went on the defensive, saying that the “BOJ’s bond purchases haven’t faced problems” (a lie), and that they “don’t think JGB liquidity has fallen” (another lie). Central bankers enjoy fibbing to inspire confidence, don’t they? But I digress.

The image below shows the direction of the Japanese economy for the last 20 years. We should empathize with Abe and Kuroda, as they need a lot more confidence in Japan than a few trillion yen of QE can conjure up!


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A lesson from the Fed

The FRBSF (Federal Reserve Bank of San Francisco) published a piece yesterday titled “Persistent Overoptimism about Economic Growth.” In it, authors Kevin Lansing and Benjamin Pyle describe how the FOMC (Federal Open Market Committee) has consistently missed projections on economic growth since 2007, ignoring the fact that the US was in a debt deleveraging cycle. The Fed released projections for real GDP (gross domestic product) growth four times per year, every year, so it must have missed guidance almost 30 times! Wow, what a great track record. So, where can we find these projections? The SEP (Summary of Economic Projections) provides these projections. Growth rates usually have started high, but have been revised down numerous times as data has missed expectations.


If one looks closely at these reports, it is apparent that the SEP forecast for 2008 never in fact turned negative. “The mainstream view was that the US economy would avoid a recession despite the ongoing housing market turmoil.” The actual growth rate that year was -2.8%. So, our conclusion is that central bankers (or wankers), like other economists, are almost always wrong in their predictions and oftentimes in their policies as well. If they don’t have the correct forward data, how can they make correct judgments all the time? These guys and gals tend to “follow a natural human tendency to assume that recent trends will continue.” This is otherwise known as extrapolation. I don’t know about you, but all my statistics professors in high school and college strictly asked students to avoid or take caution before making conclusions based on extrapolations…perhaps Bernanke slept through this one?

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So, central “wankers” aren’t just making bad estimates. They’re also using false data?

By this time, individual investors should be wary of central wankers in general, but get ready for this…not only can they be wrong, but the actual data they use can be completely inaccurate as well. Today, Gallup’s CEO called the 5.6% official US unemployment rate a complete farce. Some of you may know that the US Department of Labor doesn’t consider individuals who have dropped out of the labor force to be among the unemployed, even though these poor souls may not work again for years. What if you are an engineer who works one hour per week as a consultant for a poorly funded startup in your friend’s garage? Are you employed, according to the DOL? Yes! Are you really employed? No.

Gallup, on the other hand, “defines a good job as 30+ hours per week for an organization that provides a regular paycheck.” The employment in this category is 44% of the adult US population 18 years or older. The organization argues that to get this ratio up to 50% by creating 10 million jobs would be a great start towards creating a sustainable economic recovery. The answer to the White House’s question of why the middle class isn’t “feeling” the current market recovery is that this recovery doesn’t affect their lives as much as it does their CEO’s pockets.


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Gallup presents the graph above as a more accurate depiction of labor in the United States. We will save the discussion on the abuse of disability claims and youth employment for a later piece. For now, just think about how wrong both the data and policymakers have been since 2007, and consider that things are probably worse overseas.

Why should we care about what’s going on abroad?

Well, for one thing, ongoing currency depreciation overseas and US dollar appreciation have resulted in numerous earnings misses for S&P 500 exporters like Caterpillar (CAT). Similarly, emerging market companies should see lower earnings, as they are being paid by their customers in cheaper currencies. Let’s see…what else? The Swiss National Bank’s (SNB) foreign exchange move last month resulted in wiping out dozens of small and mid-sized broker-dealers and almost caused the bankruptcy of publicly traded FXCM. So, we could not only see more ex-US gradual currency depreciation. This could be accompanied by high levels of market and currency volatility as well.

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Additionally, investors like Chelsea Clinton ‘s husband Marc Mezvinsky have gotten absolutely smoked on European bets, including a recent one on a Greek recovery. In an investor letter, Mezvinsky admitted that he was simply “incorrect” in his investment thesis. One of Mezvinsky’s smaller funds focused on Greece was down 48% recently. Luckily, Lord Lloyd Blankfein invested in the flagship instead. A 22.0x price-to-earnings ratio and potentially declining earnings growth make investing in certain areas of Europe like investing in a train wreck waiting to happen. Short-term movements could be exciting, but watch out! Investor losses abroad could affect banks and investors in the United States as well.

Greece, the final frontier…

Futures were much higher yesterday on rumors that Greek Finance Minister Yanis Varoufakis was planning to end a debt standoff by claiming that the government would no longer call for a headline write-off. What he instead proposed was a write-off that would not be called a “write-off” or a “haircut,” but would be called a more politically acceptable “debt swap.” Brilliant? No, this is the same type of tomfoolery that got Greece in trouble in the first place.

This is my imaginary conversaton with Varoufakis:

Varou: “Are GDP-linked bonds a good idea?”

Me: “Perhaps, Varou, if your GDP stays low forever, you won’t pay a dime!”

Varou: “Are perpetual bonds a good idea?”

Me: “I thought perpetual means that they never have to be paid back?”

Varou: “Exactly!”

SMH (shaking my head)

Unfortunately, both Germany and the ECB have not let Varoufakis get this far, as they have both said no to Greek proposals. It looks like Germany will hold back its negotiating points until Greece literally runs out of funds in one month. Look for the market and oil to be lower today after digesting this information, along with higher crude oil inventory data.

Stay tuned,

Liam Odalis


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