At the dawn of a new year, and a new U.S. presidency, global fixed-income investors look tentatively at a strange landscape in which old rules about bond behavior and the money supply don’t seem to apply. It’s as if the laws of physics stopped.
The world’s government and corporate issuers are unleashing massive amounts of debt not seen since World War II. Yet, astonishingly, real and nominal yields are running near zero. At the same time, the massive debt issuance has not led to runaway inflation—or anything like it.
In that kind of environment, traditionalists might foresee a hard, unpleasant, perhaps nose-bloodying reversion to the mean on the horizon—a spike in inflation that doomsayers have been anticipating for years, one that creams long-term bonds.
But that’s not necessarily in the offing, said Jim Cielinski, the global head of fixed income at Janus Henderson Investors, who spoke about the year ahead in global debt during a webinar Wednesday titled “Zeroes And Ones: Unlocking The Code To Fixed Income Investing In 2021.”
That’s because of a historic upset in supply and demand and the higher rates at which people saved in the lockdown. In other words—yes, there’s lots of cheap money around, but it’s not necessarily moving. People are banking it. (The Bureau of Economic Analysis noted that the U.S. personal savings as a percentage of disposable income soared to 33% in April 2020 from around 13% in March; it later settled back down toward the end of the year.) The demand still needs to ramp up to meet supply.
And unprecedented amounts of policy interference—in the form of massive central bank accommodation and fiscal stimulus—have provided a backstop that changes the laws of money physics.
“Things are not normal,” Cielinski said. “We’re going into 2021 with so many relationships that [are at] historic highs or wides or narrows. … We have never seen this much debt with this little inflation, for example. We have never seen credit spreads this tight in the face of metrics and leverage metrics that actually look so bad. Again, the markets are pricing in improvements. But equally, [there’s] so little yield. Globally we have record low yields. And that’s true [in] both nominal and real terms.”
Much of that price behavior is explained by what central banks are doing, he said.
“Policymakers have altered the definition of what a fundamental is,” he said. “Central banks have told you what they will do in a crisis.” Central banks have essentially offered a put option—showing they will intervene to save wavering assets, and directly involving themselves in the supply/demand equation, Cielinski said.
“With this number of extremes, you should not be thinking that everything just mean reverts,” he said. “I think you’re supposed to say to yourself, something is different.”
He said that the world, while reeling from the shock the coronavirus gave to GDP growth, has also been surprised at the recovery. “The lesson is that if you replace lost income, that is really the key to driving growth forward,” he said.
Bond prices do not simply reflect strained leverage metrics and possibly poor credit quality—but also the fact that investors expect companies’ cash flows and earnings to come roaring back as the world emerges from the sleep of the pandemic, he said.
“I’ve heard so many people talk about what seems to be a disconnect in valuations and the underlying fundamentals. I think that’s a mistake. You have to look beyond traditional fundamentals,” he said. Earnings, cash flow and leverage metrics are still important, he added, but “policymakers have engineered record-low real rates in many parts of the curve. … So for companies to borrow at these levels, it typically means that as long as you don’t make a mistake, you won’t default.”
How can you print so much money without having inflation? “The answer last year was actually a fairly easy one,” Cielinski said. “Money and money growth went up dramatically at a record pace almost everywhere. But it didn’t go anywhere. This was my point about people taking money and putting it under the mattress, maybe investing it. But they weren’t spending it. They weren’t borrowing against that money and creating that real credit demand that is normally quite inflationary. So this is why you didn’t get inflation last year.”