Wednesday, November 9, 2016

Gary Shilling Business Insider interview

BI: A while ago, you put a 1% forecast on the 10-year Treasury yield, and 2% on the 30-year. Are you still bullish on bonds [implying that bond prices will rise and their yields will fall]?

Gary Shilling: Yes I still am for three reasons. 

One is the safe-haven effect. We're in a pretty tumultuous world, and there's a lot of uncertainty. Treasurys are where people go as one of the few safe havens in the world.

The second thing is that despite the recent conviction of many that we're headed back to inflation, I think deflation remains the more likely prospect. You've just got too much excess capacity in the world.

The third reason is that Treasurys, as low as yields are, are higher than they are in most other developed countries. A foreign investor picks up a yield spread in Treasurys versus their own sovereigns, plus the fact that if the dollar is going to continue rallying — and I think it will because it's a safe haven — then they get a currency translation gain as well.

BI: But with the specter of a Federal Reserve rate hike coming, do you see any upward pressure on yields?

Shilling: Not really. If you look back historically at the post-WWII period on average, if you get a 100-basis-point increase in Fed funds, the spillover to the ten-year is only 35 basis points, and 25 basis points into the 30-year — it’s a fairly small spillover effect.

Another factor here is that I think that the Fed wants to raise rates because they’ve been yelling and screaming about it. They’ve been crying wolf for so long that their credibility is shot, and I think they feel they need to.

Investors aren’t willing to accept the idea that we’re in an era of lower returns. And the Fed worries about those distortions.

One of the things I think is very likely is that with the prospects of robust fiscal stimulus in response to voters mad as hell, the Fed is going to be in there with helicopter money. In other words, they’re going to be buying whatever the Treasury issues. They’re not going to, in effect, advocate strong fiscal stimulus and then not finance it. And that’s helicopter money.

BI: Oil prices have held in a $40 to $50 range for some time even though there's been no solid OPEC agreement and US inventories are still high. Why are prices still holding up, and is there a bigger correction coming?

Shilling: I think so.

There was a bounce a year ago that didn’t hold, then you got down to $26 per barrel on WTI in February, then you got up to about $50, now we’re back to $45.  I said earlier last year that I thought we’d get to 10 or 20 bucks because that’s the marginal cost, and when you’re in a price war, it’s the marginal cost that determines the price.

It is a price war because basically the OPEC reason did not cut production in their November 2014 meeting was that they got tired of cutting production and having American frackers and Russians etc grab market share. OPEC production went from 30 million barrels a day to 33 million. They flooded the market, and it’s lost them a lot of money. Look at the Saudis: they just floated a $17.5 billion debt offering, they earlier borrowed $10 billion from a group of international banks; they’re selling part of Aramco — they’re desperate for money.

What’s happened is that in their game of chickens, they are the chickens. The cuts they’re talking about are not meaningful — about 600,000 or 800,000 barrels a day, which is easily made up by frackers who are now coming back to life with increased productivity, and Russians as well.

So they are right back to where they were, except now they have lower credibility. They are the swing producer, and of course the serious question is whether they’re going to get agreement. They already exempted Libya, Nigeria, and Iran. I think it was just wishful thinking that they were going to do anything to agree to cut production meaningfully in any way.