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Business/Finance See other Business/Finance Articles Title: Alice in Wonderland Economics Alice in Wonderland Economics Boris Schlossberg | Thursday, August 11, 2016 at 4:30 pm Little wonder that Lewis Carroll was English, for there is no greater example of our Alice in Wonderland economy than the current state of the U.K. bond market. Let’s review. Two months ago, U.K. citizenry – much to the shock of everyone around, including themselves – decided to vote the country out of the European Union. Almost instantly, the low-information voters experienced buyer’s remorse in what is now being called Regrexit. But never mind. Cable collapsed. Business sentiment data saw the biggest drop on record and last night’s very important RICS report was a disaster. “[Residential real estate] sales dropped the most since the financial crisis in 2008,” according to data from the Royal Institution of Chartered Surveyors. “Prices rose at the slowest pace in three years in July and new sales declined.” Understand that in no other G-7 country is the consumer more levered to the price of real estate than in the U.K. A drop this large will almost certainly impact consumer spending going forward, which in turn could send U.K. GDP into contraction in the second half of this year. It’s no surprise that two weeks ago, the Bank of England decided to cut rates. It’s no surprise, therefore, that two weeks ago the Bank of England decided to cut rates and expand its QE program in order to stimulate demand the only way they can. But here is the rub: At the most recent U.K. gilt auction, the Bank of England could not find enough bonds. Bloomberg describes the central bank’s policy failure this way: “The central bank failed to buy enough gilts to reach its stated goal at an operation on Tuesday – the first such failure since it initially started quantitative easing in 2009. The yield on 10- and 30-year bonds fell to records after the operation. The BOE, led by Governor Mark Carney, said on Wednesday that it will incorporate the 52-million-pound shortfall into the second half of the six-month program.” Why did this happen? Because in a low-rate environment, pension plans have to hold on to their long-term bonds. If they think yields will continue to fall, the last thing they want to do is give up their income as their future liabilities are already under the huge threat of mismatch. So the end result is that in a country whose economic prospects look increasingly grim, investors are actually in a mad rush to buy the bonds even though tax revenue supporting those bonds is likely to shrink. This is the upside-down world of finance that we live in now. The U.K. is headed the way of Argentina, but its bonds are at record highs and yields are at record lows as investors ignore the economic risks. Could everything turn out OK? Let’s hope so. But if it doesn’t, U.K. gilts will be one of the greatest short trades ever. Because just like with the housing crisis of 2008, everything will be OK, until it isn’t. Post Comment Private Reply Ignore Thread
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