Confronting a Joyful Disorder: Bonds, Yields, and Negative Equilibrium

Over the course of the last two weeks, we have been observing a twist in the bond markets. Yields are rising and consequently bond prices dropping. More than $420 billion worth of paper wealth has been wiped out in the bond markets across the globe.

The rooster of negative yields and the trajectory of a negative equilibrium we started talking about three weeks ago (see http://blacksummitfg.com/2960 and http://blacksummitfg.com/2987) came crowing home, telling us that the mirage of deflation and secular stagnation may just be a propaganda.

On top of this, the reality of supply and demand for Treasuries and bonds in general (given the QE has deprived markets of good collateral) as well as the fact that bond buyers (and especially the primary dealers of the Fed) may be hearing the rooster of even higher deficits to finance an unsustainable situation, create an environment of financial purgatory as explained below.

The speed by which the bond market changed direction not only is rare but also indicative of the volatility that will continue characterizing the markets this year. German yields on two and five year notes were negative, assuring that investors who held those notes until maturity will lose money! This is the epitome of absurdity in an environment where placebo treatments are taken as scientific prescriptions that cure the financial cancer of debt overhang. The graphs below demonstrate the significant turnaround we have been observing in the bond markets and particularly in the German bunds (in terms of dropping prices and higher yields).

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