The most significant issue developing on the world stage is the continued decline in German bond yields, which are now heading towards zero.
The ongoing fall has significant ramifications for global financial risk and the valuation of assets (including shares), which investors need to be aware of.
Yet the European Central Bank and its President, Mario Draghi, seem to be in denial about these risks.
Late last week, the German 10-year bond suffered what’s being described as its ‘Freaky Friday’ when the yield fell to just 0.051 per cent. It was freaky because as Greece teetered on the brink of default there was a mad rush to the safety of German bonds.
Figure 1. German 10-year government bond yield
Source: Thomson Reuters
Bond yields there now look likely to head towards zero.
We believe this is a warning sign. We now have a full-blown German bond-market bubble that is blowing hot air into an equity market bubble.
If risk-free rate of return is hitting zero, and the market believes it is sustainable, then every asset price looks cheap. If speculators buy into that, they could create a massive speculative bubble in the equity market.
But the ECB talks down risks
The warning signs from the German bond market come as Greece heads towards default because the ECB is not prepared to support the country due to rules put in place around its QE program.
Despite these warning signs, the ECB continues to talk down risks.
In a news conference last week, Draghi said there was a risk the ECB’s stimulus programs will fuel fresh asset bubbles. But “so far we have not seen any evidence of any bubble,” he said.
Is he seriously suggesting that German bonds are not in a bubble?
Draghi also said he was targeting an inflation rate of 2 per cent. Does anyone understand how the bond market can head to zero, but the ECB is targeting inflation of 2 per cent?
Deep into the muck
We believe the ECB has no idea what is happening, and that investors need to be aware the ECB has no idea where it’s taking financial markets.
Central banks are operating on hope, rather than the true belief that what they’re doing is correct.
We have been in uncharted territory before, but with bond yields in the likes of Germany falling so low, we have now gone deeper into the muck.
But don’t expect the ECB to be challenged by financial commentary from large investment banks. While investors have become too reliant on central banks it is the financial institutions’ business models that have benefited from the unlimited support from central banks.
Our message is simple. Be aware of what is going on and do not expect any Central Banker to really tell the truth.