In a market gone mad, who knows what bonds can yield

In price is knowledge," one editor used to scream at me. Whether or not you believed in efficient markets, you could be sure the price of a bond, a currency or a commodity was trying to tell you something about the outlook for growth, inflation or monetary policy. All you had to do was listen and translate.

Not anymore. The ad-hoc combination of quantitative easing, government stimulus packages and zero-interest-rate policies has distorted markets beyond recognition.

In short, it is almost impossible to make a coherent argument for what a 10-year Treasury should yield, what a dollar or euro is worth, or whether to buy or sell copper or gold. Following are examples of markets driven mad by the recent enthusiasm for government intervention.

The 10-year US government bond yields about 3.5 percent, down from a five-year average of 4.14 percent and its 20-year average of 5.57 percent. Today's level, though, is about as reliable as the price of a collateralized debt obligation in the depths of the credit crunch.

The combination of US authorities keeping the fixed-income market on life support by buying debt, plus commercial banks filling their balance-sheet holes with top-quality government securities, makes the Treasury yield an exercise in marking-to-myth.

With bonds as your guide, you would never guess that the US Treasury plans to borrow a net $276 billion for the October-December period and a further $478 billion in the first quarter of next year, or that it expects to hit its $12.1 trillion debt ceiling some time next month.

If anyone is worried that the multitrillion dollar global Keynesian experiment we're in the middle of might backfire and ignite inflation, they haven't told the Treasury market. Maybe they have been whispering instead to the gold market.

Gold has reached a record $1,095 per ounce last week after a 25 percent gain so far this year. You know markets have gone mad when the 10-year Treasury couldn't care less that gold is at a record.

Investors who own European corporate bonds have made more than 15 percent this year on a total-return basis, according to figures compiled by Deutsche Bank AG. Subordinated debt sold by financial companies have delivered more than 26 percent. In Europe's high-yield market, junk debt has returned a spectacular 67 percent.

You will struggle, though, to find anyone who trusts the rally. Too much money, with nothing better to buy, indiscriminately rushing back into the credit markets - that seems to be the culprit. Never mind that the default rate among high-yield companies in Europe reached 9.3 percent at the end of the third quarter, up from 6.4 percent in the previous three months, according to Moody's Investors Service.

The rating company is predicting speculative-grade bond failures will peak at 10.9 percent this quarter, before almost halving to 6 percent a year from now. That seems way too optimistic, given the economic carnage wreaked by the credit crunch on corporate creditworthiness.

You know markets have gone mad when corporate bonds promise equity-style returns. It can mean only one thing: Investors should brace themselves for the equity-style risk of losing all of their money, not the security of regular interest payments.

Mark Gilbert is the London bureau chief and a columnist for Bloomberg News. The opinions expressed are his own.

(China Daily 11/09/2009 page11)