The Author is a former UK Gilt Market Maker and a developer of Systematic evidenced based Trading strategies.
For over 9 months now I (my Models) have consistently refused to succomb to the interest rate “Bears” warning of impending Capital losses in Fixed Interest………….until now? So let’s take a look at some of the major Govt Curves and Yield Changes since Jan 1 2014 (below) We now have negative yields at the front end of Germany , with the Irish (not in the Table) also able to issue short paper with a negative yield ( a far cry from the Celtic Tiger “Bust” days with Ire 10yr collapsing from 11.8% to 1.69% ( For those who are not familiar with duration in Capital terms it equates to a move of circa 80 pts. (Well done Boston by the way! ).
The problem with Fundamentals for the layman and often even market Professionals is to understand the counter intuitive effects of distorted economic policies in the markets and, more importantly, how long these may last. For example, how could anyone have seen Eur 10’s 30’s Steepen 80 bps while Usa and UK “Flatten” 12 bps or that Spain 10 yr with the spectre of defaults would trade through (lower) the Usa 10yr? Many could have naturally assumed it would be a good thing to fix their mortgages in 2007/2008 with the spectre of rising interest rates. Even in Jan 2014 a rate rise ( albeit from a very low level) seemed close and yet, as we can see from the Table above, the unlikely scenario of “deflation” from Q1 is now almost an accepted reality as evidenced by the “Chase for Yield” (above). Maybe we are storing up just a bigger bombshell for the future? The analagous image of “10 Fat people trying to get out of a lift at the same time” is always with me but so far “There is NO wage inflation”.
However, my Contrarian Model is beginning to give me advance warning of some early “Divergence DOWN ” signals in Fixed Interest so I am moving from an “Overweight Fixed” to “Benchmark” and may even consider an “Underweight” as Uk 10yr approaches 2.23% ( Curr 2.28%) which equates to Gilt (Dec) 10 yr Future circa 115.20 at which point I will re- assess the situation and follow with a “Short Signal” update. Considering we have had 3 quarterly Futures rollovers which means that 106 in Gilts (Mar) would be equivalent to 103 (Dec) so the market has moved up 12 pts in 10 yrs. That’s a lot of Capital gain left on the table and “Red faces” to Trustees. The big unknown will be does Real Money continue to try and play catch up and chase yield even further out the Curve >10 yrs and if so, to what extent? and for how long? There’s that lift again!!
In conclusion it is an unlikely co-incidence to make the point that as well as the “Interest rate Bears” being hurt so too have been the “Commodity Bulls”. All year I have been receiving “Spam Emails” telling me ad nauseum that “Silver’s Time is Now” well actually now Silver is down 30%. Suddenly last week the emails stopped coming? Not so strange then, that today, I got a Contrarian signal to “Exit Shorts” in Gold ( I stress not yet to go Long)…………………..I wonder, I wonder?????