Rising bond yields are simultaneously both minor and serious

The last week or so has seen quite a change in world bond markets. We had got used to yields plunging and prices rising as more and more sovereign bond yields went into negative territory. Indeed we even saw two Euro area corporate bonds issued at negative yields as investors paid to own bonds issued by Henkel and Sanofi. This was because of a situation described like this by the Financial Times.

It was a first. It was exciting.

From Morgan Stanley, with our emphasis:

We estimate that a total of €467bln of EUR IG bonds now have sub-zero yields. Of this, €313bln of bonds are iBoxx index-eligible, split 39% and 61% between financials and nonfinancials. Thus, ~25% of the EUR IG index is now in negative yield territory, with the concentration increasing to 33% in the CSPP-eligible universe.

CSPP is the corporate bond purchase program of the European Central Bank about which we will be updated later but as of last week totalled some 20.5 billion Euros. Oh and by IG they mean Investment Grade.

Quantitative Easing

Such moves are of course on the back of the various bond purchase programs of several of the world’s major central banks. The scale of the purchases was highlighted in the ECB press conference as Mario Draghi was asked this.

Does this include also the capital key, or would you argue that changes to the capital key are politically too sensitive to really discuss them?

The capital key is an issue for the ECB because it is buying the sovereign bonds of a number of different nations or as Paul Hardcastle put it.

Ninininininininininin 19 nininininninin 19

There are obvious issues when you are buying the bonds of Spain and Italy who are currently breaking the fiscal rules and the arrangement is that bonds are bought in proportion to each country’s stake in the ECB’s capital. The problem as yields fell was that the ECB could run out of German bonds to buy as so many of them were below the -0.4% Deposit Rate threshold.

However the ECB is continuing with this.

Regarding non-standard monetary policy measures, we confirm that the monthly asset purchases of €80 billion are intended to run until the end of March 2017, or beyond, if necessary,

Meanwhile the Bank of Japan is doing this.

The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen…… The average remaining maturity of the Bank’s JGB purchases will be about 7-12 years.

Much nearer to home for me the Bank of England has recently rejoined the party.

On 4 August 2016 the MPC voted to increase the stock of purchases of UK government bonds by the APF to £435bn.  In addition, the MPC voted to make up to £10bn of purchases of corporate bonds over 18 months

It operates under a different structure where it buys in particular maturity zones so for example this afternoon it will purchase some £1.17 billion of UK Gilts out to the 2023 maturity.

We got used to a litany of record lows for bond yields and record highs for prices. If you think about it sovereign bonds which are supposed to be low risk heading towards 200 against a nominal value of 100 does pose serious questions.

UK Pensions

There have been clear casualties from all of this and if we look back over the period of lower bond yields we see that defined benefit pension schemes in the UK have been an example. Mercer have pointed out this earlier today.

To put this into context, since 2010, companies have contributed an estimated £75 billion of cash (almost 5% of the value of the liabilities) but in that time we have seen no material improvement in funding levels.

More fuel for my arguments that QE can adversely affect the economy which is a antidote to the rhetoric of the central bankers and I also not this.

Consequently, pension scheme liabilities now represent 40% of the market capitalisation of FTSE 350 companies compared to 30% at the end of 2010 . This demonstrates the way in which the finances of pension schemes have grown in importance in relation to the overall size of UK companies.

Are you still wondering why companies are not investing? Oh and in case Andy Haldane of the Bank of England is making a sorely needed effort to learn a little more about the world here is an update on the pension he claims not to understand.

the latest figures show the Bank of England’s gold-plated scheme has edged into fully funded status.


the Bank had increased contributions to 54.6 per cent of members’ pensionable salary in March 2015, up from 51.8 per cent in 2014 and 24 per cent in 2011.

So Andy and his colleagues are all right Jack ( and Jill).

This issue of more and more people questioning QE is a serious one and it has led to a change in the zeitgeist and beyond. The Bank of Japan changes its story nearly every day and even the Japanese owned Financial Times is on the case. Mario Draghi raised his rhetoric to frankly ridiculous levels as he told the press corps this on Thursday.

right now the transmission mechanism is really working very well. It’s never worked better.

Tell that to the unemployed.

Bond Yields rise

Whilst we were seeing what the FT above called “exciting” ( I know they have a nice cake trolley but they should get out of that building by Blackfriars Bridge more….) there were rumblings of ch-ch-changes. As ever they began in Japan where in spite of the Tokyo Whale yields began to rise. If we look at the ten-year yield we see that it did not quite make -0.3% in July and since then has been rising and today nearly made 0%.

Germany has seen its ten-year bund yield rise from negative territory as it follows the same themes and today it has gone positive. This has generated not a few “its doubled” tweets as it has gone from 0.1% to 0.2% to 0.4% which shows that as ever with statistics and numbers care is needed. In some ways the changes are minor but there is something significant. Let us switch from what are small yield changes to big capital ones and let me illustrate from Japan.


As you can see the situation is very different if we think of potential capital losses on longer-dated bonds. The 15% loss assumes of course that someone invested at the top. Sadly we know from the past that this does happen and incidents such as the collapse of Long Term Capital Management with its Nobel Prize winners on board shows us how dangerous it can be. The financial and economic world is much more highly strung and indeed wired that it was back then.

Ireland and Belgium both sold 100 year bonds this summer with Ireland issuing its at a yield of 2.35%. Imagine the impact on them if yields backed up more? Or a pension fund cutting its losses and buying bonds right at the top…

Here is an estimate of what this might cost.



There is much to consider here and the issue of changes being minor is the actual yield or interest-rate change where for example Japan and Germany can still issue bonds for pretty much nothing. Even in the UK the ten-year Gilt has gone from just over 0.5% at the nadir to 0.88% as I type this. On the scale of the drop this is not far off a pin prick.

However when we move to capital changes as I have highlighted above the situation is very different especially if someone cut their losses or invested at the top. Also officially government bonds are low risk now please long again at the Japanese equity bond comparison above where bonds are moving much more than equities.

This might be a type of taper tantrum but there are dangers in it should it continue in another sign of how little recovery we have actually had. Also it is my opinion that Mario Draghi and the ECB wanted this and behaved in such a manner on Thursday to get bond markets to fall and ease their capital key problem. That is a dangerous game as not everything can be centrally planned and controlled and they may yet find that they are holding a tiger by the tail.


9 thoughts on “Rising bond yields are simultaneously both minor and serious

  1. Shaun,
    I understand Primark’s pension scheme has gone from surplus last year to deficit now – as you highlight the corporate freebies paid for by savers and pensions. Await panic in equities now the A teams are back from their holidays as up to now minimal volatility has reduced trading profits?

    • Hi Chris

      Yes I saw that earlier which is an actual example of the generic pensions issue in the QE era we have discussed many times on here. From Professional Pensions.

      “Associated British Foods (ABF) expects its defined benefit (DB) scheme to have a £200m deficit by the end of 2016 due to tumbling bond yields.

      The FTSE 100 company which owns retailer Primark made the revelation in its pre-close period trading statement after the scheme had a £90m funding surplus last September.

      The £3bn UK scheme which is closed to new members recorded £3.3bn of assets and £3.2bn of liabilities on an IAS 19 accounting basis as of 12 September 2015.”

      As to the markets there was a rally today as the Plunge Protection Team appeared or to put it another way the speech from the Federal Reserve member (Brainard) which was supposed to hint at a rise was in fact not so.

  2. back from sunny Bournemouth and Brighton

    in both cases I think our hotels will fail if we restrict EU workers (!)

    a side note was the amount of foreign accents in Brighton , workers or holiday makers – both from what I could make out . God it was expensive compared to abroad ( but not other EU countries like Italy or Germany )

    Anyway back to the plot – with a round of gas/leccy prices rise due soon I worked out I had over 6 years about 3.8% per annum increases in leccy despite moving firms , tag that with food bills and theres the inflation for the little man for you

    as for houses………. yikes !

    The who scheme I think is to get the money from the pension pots and support the Banks with it , next they’ll tax the BtL brigade as they’ll be the only ones left to blag

    8 year of support and the daft bu@@ers are still broke ?

    Shaun , are you the only one looking ?

    Crikey we’re in the poop for sure and the turn a round will be a blinder , as in ” sorry gov , despite the huge wonger we draw ,we still could not see it coming ….. never mind our stash is safe ” :- )

    yours ?? , pfft !! , well we’re alright Jack


    PS solve the housing crisis by allowing the tenants of BtL the right to buy , discounted of course(!!)

    • I have just returned from a holiday in Ireland and as you comment, many foreigners! Good news for the irish tourist trade and it will no doubt help the real economy as it is going directly to the man in the street. Time and again the reason given for people taking holidays in ireland was fear of terrorism in other countries. I wonder if this and the cheap pound is helping the UK? Having said that there is a significant increase in the number of Brits in Ireland so the exchange rate isnt putting them off travelling. Things are definitely looking up for the Irish but the Apple saga and its ramifications could put a hole in the future.

      • Many in the UK remember £/€ parity, and around €1.15/20 is what we were getting not so long ago, so although a recent dip, definitely, not one to where we haven’t been recently.

  3. Hi Shaun the currently omnipotent Central Banks as you point out are controlling supposedly free markets.So am not sure where the danger is ,if there is a sell off they just create more money out of thin air and suppress yields further.
    I realise they should not be able to do this as monetary expansion is historically inflationary Logic suggests confidence in these ridiculous policies should have evaporated several years ago but it has not and what would be the catalyst for such a loss of confidence?

    • Hi Private Fraser

      There are lots of issues here and a big one was driven by the central banks as Mario Draghi acted as if he wanted a setback on Thursday and then we had false hints of a hawkish speech from a US Federal Reserve member today. The danger is as I highlighted that such swings could catch someone out especially as the game is to front run the central banks. What if someone has a really geared position with derivatives thinking the only way is up?

      As to the events you highlight they can come out of the blue. I remember being on LIFFE back in the day when the Russian crisis began on a Friday lunchtime and things dribble in,complacency rules okay and then boom!

  4. Hi Shaun, this is what I was alluding to on 5 September here – https://notayesmanseconomics.wordpress.com/2016/09/05/another-failure-for-the-forward-guidance-of-the-bank-of-england/#comments:

    “On bonds I see some signs of significant inflationary pressure building, likely to arrive next summer, but it’s too early to make a %age prediction yet as these pressures may yet recede. If they don’t, I think the Pension funds will be able to begin to sit back and relax next Autumn whilst the BOE does it’s all to try to drive prices up again but it will be to no avail unless it chooses direct debt monetisation.”

    I was speaking solely about the UK of course. Whilst Pension companies will take initial hits this should only be a short term problem as yields rise inexorably and stay higher permanently due to the new cycle I believe the UK is entering.

    I am puzzled as to the behaviour of the Japanese and German sovereigns though – profit taking by speculators?

    • Hi Noo2

      I agree on the UK where the Bank of England QE program has taken yields to crazy levels if you look at the likely inflation trajectory. It was upwards before the circa 1% boost provided by lower post Brexit pound yet the QE program bought out 2021 Gilts at 0.3% today. Crackpot!

      I tend to agree on the pension issue but the danger is that someone hedges here in the way that the Standard Life pension fund did at the bottom of the Gilt market.

      As to the Japanese and German markets I think that this has been led by Japan where the Bank of Japan has sent so many confusing messages and a yield of well below 1% for 40 years? Maybe they will have another 4 lost decades but there is no margin for error there….

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