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Looking for Logic

Now don’t get me wrong, says Michael Wilson. I like a bit of unpredictability just as much as the next man.

Show me a long sweeping upward curve, and I’ll probably start fretting that Mr Market must surely be over-simplifying things and that it’ll all end in tears. Show me a long, slippery descent, and I’ll be out there with my resistance lines and my theory books, trying to spot the crucial turning point that will make me rich. Life isn’t easy for us fidgety contrarians.

But this year has got me properly foxed. Sure, it doesn’t surprise us very much at IFA Magazine that the equity bull run has flagged this year. (We said last November that there wasn’t enough substance to support any further rises in company valuations. Tadaaa, thank you.) But the recent tightening of bond yields? What does that mean?

I wish somebody would tell me. Yes, I can see that Russia’s threats toward Ukraine will have been giving equity investors some sleepless nights. And yes, it’s rather disconcerting to see Japan’s QE-fuelled rocket plane burying itself into the tarmac so soon after its launch. But why bonds? Weren’t we being assured only a few months ago that investors were staying in cash, and to heck with the dismal deposit returns? What’s changed?

Whatever it is, it’s getting beyond a joke. Bad boy Greece is currently yielding only 6.3% on ten year paper; Spain, Portugal and Ireland are on 3.1%, 3.7% and 2.7% respectively. Meanwhile Germany is down below 0.2% on two year bonds. And the market’s appetite for junk bonds is positively frightening.

One of the more depressing explanations is that Europe might be flirting with deflation. The logic goes that, when consumer prices are falling, even a wafer-thin yield is suddenly worth having. The fact that you’re locking into that tiny yield for five or ten years doesn’t seem to bother other people as much as it worries me.

But whoopee, here comes the European Central Bank with glad tidings. European banks have been making superhuman efforts to repay the vast volumes of cheap rescue loans that they got back in 2011. That would be excellent news, were it not for the fact that they’re doing it for a one-off reason. Namely, that they need to improve their ratios before the next round of stress testing, later this year.

What’s that got to do with the price of fish? I’ll tell you.

It’ll swamp the bond markets, drive up the bond yield, send up the bank rates, and then we’ll all be happy. Except, that is, for businesses, which will struggle to afford new capacity at the exact moment when deflation-minded consumers are already disinclined to buy. How, exactly, is that going to help?

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