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.
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?
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 50–year 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.
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?