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By Gary Herbert, Portfolio Manager and Head of Global Credit, Brandywine Global
Those of us of a certain age can remember watching Saturday afternoon black and white reruns of Laurel and Hardy films. Invariably, after a series of laughable misunderstandings and comic mistakes Hardy would lament to sidekick Laurel, “Well, here’s another nice mess you’ve gotten me into!” Well, today’s Federal Reserve (Fed) reminds me of the well-meaning, but often bumbling Laurel, while pompous and stubborn Hardy is today’s bond market. Unfortunately, the mistakes are no longer playing out in grainy black and white, but in vivid colour for all to see.
A Fine Mess Indeed…
In late September, we saw the Fed, which had made historic purchases of U.S. Treasury and mortgage obligations across the term structure in an effort to influence yields and engender a more robust economic recovery, step back into capital markets to provide overnight and term financing for leveraged financial institutions and funds.
So much for free and unfettered markets…
Quantitative easing (QE), the novel “wet index finger in air” attempt of Takahashi Korekiyo to reflate Japan in the 1920s, was refined, appropriately quantified and ultimately academically anaesthetized by economist Ben Bernanke to become accepted monetary policy doctrine, just in case of an emergency. Well, the economic emergency came and the expected growth and strong recovery have not followed; just ask the average American. Or better yet, the Japanese and Europeans who’ve had it much worse and taken the monetary policy experiment even further.
The attempt to exit QE has been anything but watching paint dry. As far as I know, there aren’t any historical examples where QE was exited “smoothly.” Korekiyo was assassinated by a military aligned with imperial ambitions, so he never saw the tragic results of his desperate and unorthodox policies; remember, he had had limited formal schooling.
Coming to you: negative or near-zero yields on Treasury notes…
The discussion around QE and its very weak, flimsy logical underpinnings matter, because I believe that 10-year U.S. Treasury yields may approach zero in the next period of weak economic growth. The Japanese and some European economies have already beaten us there; how different is the U.S. really than those economic zones? The U.S. also has low birth rates, ageing demographics, weakening productivity and broadly increasing aggregate debt burdens.