Greed Is Back as Debt Markets Face an $8.6 Trillion Hangover

Prayers for a sudden return to dovish monetary policies have been answered, and now investors are living with the aftermath: a world awash with $8.6 trillion in negative-yielding debt.

That’s one reason money managers are wading once more into the fringes of fixed-income markets across the globe.

Consider the action over the past week: Serial defaulter Ecuador managed to sell $1 billion in new bonds even as the government is in talks for International Monetary Fund financing. Crisis-prone Greece received blockbuster orders for its 2.5 billion-euro ($2.9 billion) sale. And the decidedly frontier republic of Uzbekistan, encouraged by risk-on markets, is meeting investors for a debut international offering.

No wonder the world’s largest funds are betting the explosive rally in developing-economy debt still has legs.

Meanwhile, U.S. high-yield is in the throes of a rebound, as traders bet easier monetary policy will prolong the business cycle. Lower-rated borrowers are in vogue after the asset class posted the biggest monthly gain in seven years.

“We’ve seen a huge psychological swing toward greed from fear in the space of a few weeks,” said Jamie Stuttard, co-head of global macro fixed-income at Robeco Group in London, who’s paring credit exposure in developed markets.

It’s a replay of the post crisis, bad-news-is-good-news investing strategy. The idea: That a dovish monetary offset to redress market and growth fears will boost risk assets.
A manufacturing slowdown in Germany and Italy’s contracting economy threaten to stymie rate liftoff in the euro zone, while the Federal Reserve last week signaled it’s done raising hiking until inflation picks up.

“Markets have shown repeatedly in the past the extent to which they can ignore economic and political reality when they feel that central bank policy is a tailwind,” said James Athey, a senior investment manager at Aberdeen Standard Investments in London. The performance of Italian government bonds “is also highly suggestive of a grab for yield. We have seen a number of EM nations of varying quality come to market and see strong demand,” he said.

The case to be tactically bullish is laid out by BNP Paribas SA: Dovish central banks are the number-one reason why the new-year rally can continue with quantitative-tightening fears on the backburner. “The market will now need to rethink the consensus late-cycle narrative,” strategists led by Viktor Hjort wrote in a note.
Over at Morgan Stanley, chief economist Chetan Ahya is also giving risk takers the green light. He sees a global growth recovery in the second half led by emerging markets, fostered by a detente in trade tensions and Fed “flexibility.”

So is Goldilocks resurrected? Perhaps not.
Markets could quickly reverse recent gains, if better data pushes the Fed and ECB back on the tightening path.

“The only way that this environment can continue is if everything is just so: Stabilizing but not improving global data, the U.S. economy continues to perform well but without any upside wage or growth data,” Athey said. “That feels like a very narrow path.”
HSBC Holdings Plc is also in the naysayer camp, citing complacency over monetary largesse.
“If markets price Fed hikes again, significant curve flattening will likely put a lid on risk assets, and higher volatility looks set to stay — quite the opposite of Goldilocks,” strategists led by Max Kettner wrote in a note.