In the late medieval and Renaissance tradition Faust is a restless old wise man who sells his soul to the devil in exchange for 24 years of gnosis, power, new youth and earthly pleasures. Goethe makes the figures of Faust and Mephistopheles more sophisticated and eliminates the limit of 24 years. The doctor will have everything he wants until the moment when, having reached happiness, he will wish that the moment would stop forever.
Thomas Mann, in Doktor Faustus, reintroduces the age of 24 for Adrian Leverkuhn, the musician and mystic who voluntarily contracts syphilis in order to obtain the madness necessary to compose works of genius. Mann wrote in 1947 and killed Leverkuhn in 1940. The 24 years of madness, greatness and gloomy ruin are nothing more than Germany's adventure between the restlessness of Weimar, the National Socialist pact with the devil and final perdition.
The myth of Faust, as we can see, is in strong colors. He sells the eternal on the one hand, on the other he buys everything that time can offer. Infinite liabilities, sure, but at least the assets are large and very exciting.
The pact with the devil between the bond market and central banks, on the other hand, has the faint hues of our post-romantic, post-modern and post-everything era. The big bond rally is 34 years old, was overwhelming, and had overall few hiccups, all of which were short-lived. Not only is the rise very old, but it has also reached and exceeded the physical limits of zero rates. The youth and maturity of this rise was brilliant. It was a perfect disinflation cycle, three times longer than in the XNUMXs and four times longer than in the late XNUMXs. In this healthy phase, real rates have always remained positive even on short maturities, thus guaranteeing, in addition to formidable capital gains, also a positive carry with respect to inflation.
On the other hand, the old age of the rise was gloomy. After 2008, real rates were negative for all government bonds on the planet, even if they were more than offset by the capital gains that accompanied the fall in inflation. We forgot about it, but in the summer of 2008 the US consumer price index was up 5.6 percent. Today we are at 1.1.
After the crisis, for three to four years the market maintained a wary attitude towards the bond hike. If the economy picks up again, the reasoning was, inflation will follow. Many have therefore kept to rather short maturities and only a few courageous have embraced the thesis of the liquidity trap and have positioned themselves on a long-term fixed rate, earning hands down.
For two years, however, distrust has gradually given way to tranquillity, until reaching, in some cases, a desperate euphoria. Today the market believes (just look at the forward rates) that inflation will remain close to zero for a very long time and that central banks will not be able to bring it back up. The next crisis, it is thought, will lead us into full-blown deflation and a fifty-year bond at 2.50 per cent, like the one issued by Spain these days, will appear to be a gold deal. In any case, the market reasoning continues, central banks will prevent bonds from falling in price by continuing to buy them with Quantitative Easing and, one day, with the direct and definitive monetization of a part of the public debt.
Hence the pact with the devil. The market buys ever longer maturities and increasingly risky paper at ever lower rates because central banks have guaranteed upward life extensions with ever more aggressive forms of Qe. And it doesn't matter that the Fed's hands are itching to raise rates, because Qe will continue to push Europeans and Japanese to buy Treasuries as long as their yield is above zero.
Mind you, the devil in question, the central banks, actually wants to be a good demiurge who takes away purchasing power from creditors to transfer it to debtors so as not to make them go bankrupt. The Mephistophelean pact with the market therefore has noble aims of a general order (even if someone even worse than the devil insinuates that the roads to hell are paved with good intentions).
As for the buyers, we fully understand the professional bond managers who were overwhelmed by the flight of money from equities after the fall in January and February. We understand even more the insurers and pension funds that buy and immobilize ever longer bonds in order to be able to guarantee something to life insurance buyers and retirees. We understand the end buyers less.
With interest rates at zero, in fact, the most central banks can guarantee Faust is that returns remain zero and do not rise again (basically a joyless life extension, attached to a respirator and with not negligible hospital fees represented by the inflation which erodes the purchasing power of the bond).
It is very unlikely that rates will fall further and go well below zero, thus guaranteeing other capital gains. Central banks, including the Fed, have for some time toyed with the hypothesis of deeply negative rates, but are now backtracking and studying monetization hypotheses instead. We are all postmoderns and postmodernism has erased the notion of the law of nature. Negative nominal rates, however, appear repugnant and unnatural to us and would create a revolt with undiscovered social implications. In America, moreover, there has been a massive outcry at the political level and public opinion against the mere idea that the creditor must pay the debtor and we are no longer talking about it.
So by buying bonds now you are venturing into a labyrinth full of pitfalls. If everything remains as it is today, weak growth and low inflation, we suffer a negative real rate. Central banks can give Faust another 24 months of life with zero benefits, but then something will have to change. Even Gundlach, who in recent years has always been full of thirty-year bonds and is still ready to buy them at a discount, claims that the long bond will reach 6 percent in the next decade.
The change could take the direction desired by the central banks (reflation and gradual rise in nominal rates with real rates still negative which accompany the final, possibly long, phase of the cycle). In this case, all things considered happy, the bonds, supported by Qe, will not fall in price, but will lose more and more in purchasing power with rising inflation. To those who don't believe that inflation can go back up because they see raw materials, except oil, which have fallen again, we ask how much copper you've consumed this year and how many medical visits you've had to pay (inflation is in services). To those who say that we will never have inflation in Europe because Germany will not allow it, let us remind you that Germany is implementing an internal revaluation policy made up of wage increases of 5 per cent over two years and increases in pensions with a lowering of the retirement age. To those who argue that technology is deflationary because Spotify prevents us from buying CDs, let us remind you that the average American family spends $200 a month, and rising, on internet connections and cable TV.
The other direction that change could take is for central bank efforts to fail and we all fall back into a 2008-like situation. In this case there will certainly be strong Qe and monetizations but a generalized bailout will be impossible. Some of the risky credits on which the market ventures today will therefore be restructured or repudiated. When a bond yields zero, it therefore becomes difficult to prefer it to the stock market (in the first scenario) or to cash (in the second). Faced with the crossroads between breaking the current paradigm towards inflation or towards deflation, it makes more sense to present yourself with a stock market and cash portfolio (invested at a negative rate, be patient, in short-term securities of secure debtors) rather than filling up with long and uncertainties in exchange for a few crumbs.
That said, in the short term the world's bonds are still to be bought on weakness as long as they are sold on strength. The window granted to Faust is 24 months, perhaps 48. Better to take this into account.
