Energy vs Sovereign Bond Markets

October 9, 2022

Latest Articles:

This newsletter issue focuses on recent problems with developed country sovereign bond markets and how energy supply constraints pose an ongoing problem for them.

The Sovereign Bond Bubble

During much of 2019 and 2020, large portions of the developed country bond market were outright negative in nominal terms. Rather than getting paid interest, investors had to pay for the privilege of lending to governments and even some corporations, mainly across Europe.

At its peak, the amount of negative-yielding bonds reached over $18 trillion:

Chart Source: Bloomberg

In July 2019, I wrote an article focusing on the high probability that we were in a bond bubble. I opened the article by highlighting that even though I had some concerns about stocks, I was even more concerned about bonds:

I read thousands of emails from my readers, and one of the key themes I see is that people are concerned about the next stock market crash, and perhaps rightly so. By many measures we have high stock valuations in the United States after a decade-long bull market, and we have high corporate debt levels both inside the United States and globally.

But one question I rarely receive is: “Are bonds safe?”

From a historical perspective, the bond market is acting a lot weirder than the stock market at the current time. The stock market looks like it often does at this point in the business cycle, which is not great for the probable range of forward returns, but bonds are doing things they haven’t done ever before in history, which should give investors pause.

Since bonds are traditionally considered the safer asset class, should this be cause for concern? Are we in a bond bubble? Or is this just how things are now? This article examines the issue.

-Lyn Alden, July 2019 “Are We in a Bond Bubble, or is This the New Normal?“

Throughout the article, I went on to describe how a number of magazine covers and financial commentators were emphasizing the idea that inflation is dead, which I interpreted as a contrarian signal. Back then, and this seems ironic now, many central bankers were publicly lamenting that inflation was persistently below their targets.

I pointed out that in addition to the possibility of de-globalization and other inflationary trend shifts, the combination of aggressive fiscal policies by governments and debt monetization by central banks to support those fiscal policies, would be quite inflationary. Historically, highly-indebted countries with liabilities denominated in their own currency don’t default; they print and inflate their way out of it. As I wrote back then:

If central bank actions get more aggressive, combine with fiscal policies, and start targeting the middle class, they have the power to override these various deflationary forces with sheer monetary expansion. They can issue helicopter money to pay off debts, boost inflation, build infrastructure, bail out unfunded pension systems, and prop up the middle class if that’s what policymakers decide to do.

I wouldn’t want to be holding a 20-year or 30-year bond at super-low fixed yields in that kind of environment. Negative yields would be even…