Playing With Fire

Central banks of the world really are playing with fire. Their margin for error is much reduced. Their capacity to expand their balance sheets is now more limited. All of which means their options are diminished.

What they really risk is the markets confidence in their ability to manage the process evaporating. If that were to happen, then all bets are off.

Japan looks to be the poster child for so much. First for the demographic shift the developing world will be experiencing over the next 20-40 years, but more presciently for how the market and economy respond to unlimited QE.

Short term, the effects of QE, whether in the US, Europe or Japan, have been impressive - at least from a market perspective. Each successive policy implementation followed by a surging market response only reinforces the belief that you "don't fight the Fed." And it doesn't hurt that there appears to be some causative correlation with economic improvement. In this environment it is easy to be lulled into a simplistic notion of cause & effect which misreads the visible immediate causes against the less visible long term effects. Beware. The longer term effects are still to be tallied.

Why are bond yields so low?

There are myriad reasons why bond yields are so low. I have found it useful to list them so that I have a framework for seeing the various parts and gauging how they change over time. Here is why bond yields are so low:

(1) Relatively low inflation.
(2) Exceptionally low short term rates (controlled by the Fed).
(3) The investor fearful of deflation.
(4) The investor fearful of equities.
(5) The investor who is simply fearful.
(6) Foreign central bank buyer.
(7) Federal Reserve POMO monetization.
(8) The ride-the-yield curve financial institution buyer.
(9) The front-run the Fed speculative buyer.
(10) The momentum buyer.