About Brexit, panic and T-bonds

By Harold AGJ Davis    10 July 2016 

Most old market denizens are familiar with Charles Mackay’s 1841 classic “Extraordinary Popular Delusions and the Madness of Crowds”, and know from personal experience that it is easier to read about collective insanity than to recognize it when you are in the midst of it. After all, “This time it’s different!” Oh, really?

The remarkable political stupidity that has gripped Europe and which reached dizzying depths in Britain can only be described as a madness of the ruling elites. Now, with Europe and the U.K. threatening to unravel, a wave of anxious flight money is seeking safe havens around the world, and an extraordinary popular delusion believes that U.S. Treasury long bonds yielding 2.11% are an appropriate sanctuary from the storm. However, considering how often people in a panic make bad choices that end in tragedy, could this be another?

Panic is programmed into human behaviour. Confronted with a saber toothed tiger, our ancestors had two choices: fight or flight. But choice could be the wrong word because a response to danger is often a “no brainer” or a knee-jerk reaction toward known and established notions of safety with little or no thought about what comes afterward. So people rush to the exits leaving the trampled and suffocated in their wake. Swimmers caught in an ocean “riptide” tend to exhaust themselves by swimming directly towards shore against the flow instead of heading out through the side. Panic reactions follow the obvious, they do not consider the second move.

The notion that popular or common responses to adverse developments could be especially unrewarding was captured by Charlie, a respected floor trader in the old Canada Bond futures pit, who, when confronted by a stampeding herd of unsophisticated buy or sell orders would yell, “Run the other way!” In the current context of Brexit inspired panic buying, perhaps old traders should now question the value of US T-bonds as being grossly overpriced and yielding too little for the long term.

In a Montreal Analyst article from 17 March 2016 titled “Pitching a curve in long term interest rates” the argument was made that a curved US T-bond yield trend dating back more than a decade was going to be violated and signal a new environment in long term interest rates either before late 2016 – early 2017 or when the monthly closing yield reached the 1.90-2.00% area. A reversal could occur before either of these features. Why? Well, we could focus on negatives, but more people would be surprised by the possibility of positives.

For instance, considering that European history is full of examples of failed democracies giving way to strongmen, there is now a special incentive for constructive forward-looking parliamentarians to rally together to solve both Britain’s problems and reform the EU. Moreover, these positive politicians will find themselves gratefully well-funded and welcomed by a nervous electorate. If they try, they will succeed.

Non-believers will miss the bargain rebounds in Europe because they thought 2.11% was a deal. When they realize their mistake, their next panic will be selling T-bonds.

On this side of the Atlantic, the economic recovery beginning in 2017…Oops, sorry, that’s next month’s article.

Harold AGJ Davis is the Author and Analyst at www.prairiecropcharts.com