Is this the revenge of the bond vigilantes?

The latter part of 2016 has seen quite a change in the state of play in bond markets. If we look at my own country the UK we only have to look back to the middle of August to see a situation where the UK Gilt market surged to an all-time high. This was driven by what was called a “Sledgehammer” of monetary easing according to the Bank of England Chief Economist Andy Haldane.  This comprised not only £60 billion of Gilt purchases and £10 billion of corporate bond purchases but also promises of “more,more,more” later in the year. Not only was this a time of bond market highs it was also a time of what so far at least has been “peak QE” as central planners like our Andy flexed both their muscles (funded of course by a combination of the ability to create money and taxpayer backing) and their rhetoric.

However those who pushed the UK Gilt market to new highs following the Bank of England now face large losses as you see it has fallen heavily since. The ten-year Gilt yield which fell to 0.5% is now 1.5% as the Bank of England’s Forward Guidance looks ever more like General Custer at Little Big Horn with bond vigilantes replacing the Red Indians. Let me switch into price terms which will give you a clearer idea of the scale of what has taken place. There are always issues with any such measure but the UK Gilt which matures in 2030 can be considered as an average. Fresh with his central planning mandate Mark Carney paid 152.7 for it back in mid-August but last week he got a relative bargain at 138 and if today’s prices hold will be paying much less later this week.

This of course means that the Bank of England has made fairly solid losses on this round of QE as we wonder if that is the “Sledgehammer” referred to. So will anyone else who bought with them and I raise this as some may have been forced to buy in a type of “stop-loss” situation as we wait to see if the pain became too much for some pension funds and insurance companies. Such a situation would be a complete failure as we recall central banks are supposed to supervise and maintain free and fair markets which awkwardly involves stopping the very price and yield manipulation that QE relies on.

As we stand the overall Bank of England QE operation will be in profit but of course that has been partly driven by the new round of it! Anyway here is a picture of the Sledgehammer as it currently stands.

What has driven this?

The UK may well have been at least partially a driving force on the world scene in mid-summer but of course the recent player has been the Trump Truck on its journey to the White House. I recall pointing out on here on November 9th that this part of his acceptance speech meant that a new fiscal policy seemed on its way.

We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals.

It had an immediate impact.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

We have of course more perspective now and this morning that yield has nudged 3.2%. Of course there is ebb and flow but also we have seen a clear trend.

Crude Oil

This has also been a player via its impact on expectations for inflation. This morning the announced deal between OPEC and non-OPEC countries saw the price of a barrel of Brent Crude Oil rising 5% to around US $57 per barrel. This compares to the recent nadir of around US $42 in early August. There are of course differences in taxation and so on but roughly I would expect this to raise annual consumer inflation by around 0.5%. This time around the effect seems set to be larger as we have so far replaced the price falls of the latter part of 2015 with rises in 2016. Of course the oil price will change between now and the end of 2016 but this gives an idea of the impact as we stand.

There has also been a general shift higher in commodities prices or to be more specific a surge in metals prices which has only partially been offset by the others. The CRB (Commodity Research Bureau) Index opened 2016 in the low 370s and is now 427.

US Federal Reserve

This has had an influence as well. It contributed to the bond market rally by the way its promises of “3-5” interest-rate rises were replaced by a reality of none so far. Now we face the prospect of this Wednesday’s  meeting thinking that they probably have to do one now to retain any credibility at all. Back on November 9th I wondered if they would and there are still grounds for that as we look at Trump inspired uncertainty and higher bond yields and US Dollar strength. However on the other side of the idea I note that @NicTrades suggesting they could perhaps do 0.5% this week. Far too logical I think!

But as we look back at nearly all of 2016 how much worse could the Forward Guidance of the US Federal Reserve have been?

The Ultras

No not the Italian football hooligans as I am thinking here of the trend that involved countries issuing ever longer dated debt. If we stay with Italy though Mark Jasayoko had some thoughts yesterday on Twitter.

Italy‘s 50year bond issued on Oct 5 is down 11.33% since. = 4yrs of coupons Dear bond bulls, enjoy holding on for the next half century.

Oh Well as Fleetwood Mac would say. There was also Austria with its 70 year bond which pretty much immediately fell and I note that this morning reports of a yield rise approaching 0.1%.  Those who gambled on the ECB coming to the rescue are left with the reality that such long-dated bonds are currently excluded from its QE. As for the 100 year bond issued by Ireland in March the price may well have halved since then.

Perhaps the outer limit of this can be found in Mexico which issued a 100 year Euro denominated bond in March 2015. Of course not even Donald Trump can put a wall around a bond but it puts a chill up your spine none the less.

As we look at the whole environment we see that taxpayers have done well here or more likely governments who will spend the “gains” and investors will have lost. Should the wild swings lead to casualties and bailouts the taxpayer picture will get more complex.

Comment

So we have seen a sort of revenge of the bond vigilantes although care is needed as a few months hardly replaces a bear market which in trend terms has lasted for around 3 decades. However there is a real economy effect here and let me highlight it from the United States.

Interest rates on U.S. fixed-rate mortgages rose to their highest levels in more than two years……..The Washington-based industry group said 30-year fixed-rate conforming mortgages averaged 4.27 percent, the highest level since October 2014……..The spike in 30-year mortgage rates, which have risen about 0.50 percentage point since the Nov. 8 election, has reduced refinancing activity.

That effect will be seen in many other countries and we will also see the cost of business loans rise. Also over time governments which have of course got used to ever cheaper borrowing seem set to find that the tie which was forever being loosened is now being tightened. How is the fiscal expansionism recommended by establishment bodies such as the IMF looking now?

 

 

Advertisements

15 thoughts on “Is this the revenge of the bond vigilantes?

    • Hi CJ

      No problem I had noted that one myself! I was thinking also of the example set by India where scrapping a couple of heavily used notes has been a shambles. Venezuela is in nothing like the shape of India.

      Also it is hard not to notice how little those notes are now worth.

  1. Hi Shaun
    I think Trump will go ahead with his trillion dollar ‘investment; in infrastructure. That is all the forward guidance you need at the moment. Together with his appointments at the EPA etc , the ‘war on coal’ will end, pipelines will be completed etc, producing quite a change in energy markets.
    I am sure someone will blame ‘Russia’.

    • Hi JW

      There was another change hinted at today and as has become the way via twitter.

      “The F-35 program and cost is out of control. Billions of dollars can and will be saved on military (and other) purchases after January 20th.”

      That will no doubt have grabbed the attention of the military industrial complex and of course Lockheed Martin in particular. What next? Well rather awkward for the 2 UK aircraft carriers .just being completed which are supposed to operate the F-35. Also for other countries which have ordered them. Boeing may well be wondering if its Super Hornets will be the winner.

        • The UK’s scrapping of the Sea Harrier was one of our worst decisions. Yes with the new heavy missiles it had problems in the heat of the Gulf but in the cold air around the UK on Putin patrol it would have been fine. Upgrades and perhaps some Super Hornets in time would have been much cheaper than the F-35.
          Oh and speaking of policy by twitter the IMF seems to have joined in tonight about Greece.

  2. Hi Shaun:

    “…they probably have to do one now to retain any credibility at all” .For you maybe, but I remember the full quote which mentioned “data dependent”. It rather looks as if they did the right thing, at least until Trump got elected, now they should raise due to his inflationary policies unless they think he won’t get those policies through congress, although even then he could by pass Congress and ask State legislatures to do the spending within their States instead. American narrow money which was growing well has slowed recently so it still looks like a tough call to me whether to raise.

    As for “how worse could Forward Guidance be” well, substantially, as I don’t feel at all misled by their statements, you just have to listen to what they’re saying. I can’t wait for the misquotes of my post in any comments back to me!

    Personally I think this is a good thing and hope it will turn into a trend as it is an indicator of normalisation (i.e. pre 2009) although it will obviously hit insurance and pension companies hard. As you said in a post a few days or couple of weeks ago (roughly paraphrasing you) The only question is this: Will the forthcoming effect in the jump in money supply turn into stronger growth or stagflation. I would add “or maybe a trade off between the 2”

    • Hi Noo2

      The issue of “data dependent” has had a rough 2016 in my view. You are of course correct to say that it is chanted as a mantra. But there have been opportunities to act which have been missed, after all the data is only a guide to an unknown future which an interest-rate rise is aiming at some 18/24 months ahead.

      Whilst he is not from the US Fed we probably did learn something from the speech of Ben Broadbent of the Bank of England when he in essence said he would pick the data he wanted to ,as central bankers seem to think the same things in unison.

      We will find out on Wednesday evening ….

      • Ha ha, I can’t disagree with your penultimate paragraph – operate confirmation bias via selecting the evidence to consider that suits your pre-determined action plan, that way you can avoid any cognitive dissonance too.

  3. Tax cuts and a spending spree should be a red flag for the bond vigilantes, and antagonising one of your major lenders with a Taiwan stunt just seems ill advised.

    If China dumped all the US bonds simultaneously, they’d lose substantial savings but consider the potentail impact on the US dollar and economy.

    • Hi Expat

      China could indeed do that. However as someone who read the chaos theory books it leaves food for thought. After all if a butterfly flapping its wings over China can cause a hurricane elsewhere what would be the impact of selling these bonds on China itself?

  4. Shaun, always leading the way! The markets do seem to be backing interest rate rises, Rogoff was forecasting 3-4% inflation in the US by 2018 back on the 7th December. That kind of inflation begets interest rate rises. What is challenging is how the rest of the world responds, surely the USD will further appreciate and people will seek that return on money so it will drag the ROW kicking and screaming out of NIRP.

    It is a bit FORD F-150 truck being used in a tog-of-war against a herd of renault clios, how can you fortell the outcome?

    Paul

    • Hi Paul

      Must be very awkward for Kenneth Rogoff. How will the negative interest-rates he is so keen on go with 3-4% inflation? Badly at best in my view. As to the US Dollar it has already priced this in so could fall short term unless it thinks more of the same is on its way..

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s