Rising bond yields are feeding into the real economy

Once upon a time most people saw central banks as organisations which raised interest-rates to slow inflation and/or an economy and cut them to have the reverse effect. Such simple times! Well for those who were not actually working in bond markets anyway. The credit crunch changed things in various ways firstly because we saw so many interest-rate cuts ( approximately 700 I believe now) but also because central bankers ran out of road. What I mean by that is the advent of ZIRP or near 0% interest-rates was not enough for some who plunged into the icy cold waters of negative interest-rates. This has posed all sorts of problems of which one is credibility as for example Bank of England Governor Mark Carney told us the “lower bound” for UK Bank Rate was 0.5% then later cut to 0.25%!

If all that had worked we would not be where we are and we would not have seen central banks singing along with Huey Lewis and the News.

I want a new drug
One that won’t make me sick
One that won’t make me crash my car
Or make me feel three feet thick

This of course was QE (Quantitative Easing) style policies which became increasingly the policy option of choice for central banks because of a change. This is because the official interest-rate is a short-term one usually for overnight interest-rates so 24 hours if you like. As central banks mostly now meet 8 times a year you can consider it lasts for a month and a bit but in the interest-rate environment that changes little as you see there are a whole world of interest-rates unaffected by that. Pre credit crunch they mostly but not always moved with the official rate afterwards the effect faded. So central banks moved to affect them more directly as lowering longer-term interest-rates reduces the price of fixed-rate mortgages and business loans or at least it should. Also much less badged by central bankers buying sovereign bonds to do so makes government borrowing cheaper and therefore makes the “independent” central bank rather popular with politicians.

That was then and this is now

Whilst there is still a lot of QE going on we are seeing ch-ch-changes even in official policy as for example from the US Federal Reserve which has raised interest-rates twice and this morning this from China.

Chinese press reports that the PBoC have raised interest rate on one-year MLF loans by 10bps to 3.1% ( @SigmaSqwauk)

The Chinese bond market future fell a point to below 96 on the news which raised a wry smile at a bond market future below 100 ( which used to be very common) but indicated higher bond yields. These are becoming more common albeit with ebbs and flows and are on that road because of the return of inflation. So many countries got a reminder of this in December as we have noted as there were pick-ups in the level of annual inflation and projecting that forwards leaves current yields looking a bit less than thin. Or to put it another way all the central bank bond-buying has created a false market for sovereign and in other cases corporate bonds.

The UK

Back on the 14th of June last year I expressed my fears for the UK Gilt market.

There is much to consider as we note that inflation expectations and bond yields are two trains running in opposite directions on the same track.

In the meantime we have had the EU leave vote and an extra £60 billion of Bank of England QE of which we will see some £1 billion this afternoon. This drove the ten-year Gilt yield to near 0.5%. Hooray for the “Sledgehammer” of Andy Haldane and Mark Carney? Er no because in chart terms they have left UK taxpayers on an island that now looks far away as markets have concentrated more on thoughts like this one from the 14th of October last year.

Now if we add to this the extra 1.5% of annual inflation I expect as the impact of the lower UK Pound £ then even the new higher yields look rather crackpot.

In spite of the “Sledgehammer” which was designed by Bank of England lifer Andy Haldane the UK ten-year Gilt yield is at 1.44% so higher than it was before the EU leave vote whilst his ammunition locker is nearly empty. So he has driven the UK Gilt market like the Duke of York used to drill his men. I do hope he will be pressed on the economic effects of this and in the real world please not on his Ivory Tower spreadsheet.

The Grand old Duke of York he had ten thousand men
He marched them up to the top of the hill
And he marched them down again.
When they were up, they were up
And when they were down, they were down
And when they were only halfway up
They were neither up nor down.

If you look at inflation trends the Gilt yield remains too low. Oh and do not forget the £20 billion added to the National Debt  by the Term Funding Scheme of the Bank of England.

Euro area

In spite of all the efforts of Mario Draghi and his bond-buyers we have seen rising yields here too and falling prices. Even the perceived safe-haven of German bonds is feeling the winds of change.

in danger of taking out Dec spike highs in yield of 0.456% (10yr cash) ( @MontyLaw)

We of course gain some perspective but noting that even after price falls the yield feared is only 0.456%! However it is higher and as we look elsewhere in the Euro area we do start to see yield levels which are becoming material. Maybe not yet in Italy where the ten-year yield has risen to 2.06% but the 4% of Portugal will be a continuous itch for a country with such a high national debt to GDP (Gross Domestic Product) ratio. It has been around 4% for a while now which is an issue as these things take time to impact and I note this which is odd for a country that the IMF is supposed to have left.

WILL PARTICIPATE IN EUROGROUP DISCUSSION ON – BBG ( h/t @C_Barraud)

 

The US

The election of President Trump had an immediate effect on the US bond market as I pointed out at the time.

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%.

 

As I type this we get a clear idea of the trend this has been in play overall by noting that the long bond yield is now 3.06%.  We can now shift to an economic effect of this by noting that the US 30 year mortgage-rate is now 4.06% and has been rising since late September when in dipped into the low 3.3s%. So there will be a contractionary economic effect via higher mortgage and remortgage costs. There will be others too but this is the clearest cause and effect link and will be seen in other places around the world.

Japan

Here we have a slightly different situation as the Bank of Japan has promised to keep the ten-year yield around 0% so you can take today’s 0.07% as either success or failure. In general bond yields have nudged higher but the truth is that the Bank of Japan so dominates this market it is hard to say what it tells us apart from what The Tokyo Whale wants it too. Also the inflation situation is different as Japan remains at around 0%.

Comment

We find ourselves observing a changing landscape. Whilst not quite a return of the bond vigilantes the band does strike up an occasional tune. When it plays it is mostly humming along to the return of consumer inflation which of course has mostly be driven by the end of the fall in the crude oil price and indeed its rebound. What that has done is made inflation adjusted or real yields look very negative indeed. Whilst Ivory Tower spreadsheets may smile the problem is finding investors willing to buy this as we see markets at the wrong price and yield. Unless central banks are willing to buy bond markets in their entirety then yields will ebb and flow but the trend seems set to be higher and in some cases much higher. For example German bunds have “safe-haven” status but how does a yield of 0.44% for a ten-year bond go with a central bank expecting inflation to go above 2% as the Bundesbank informed us earlier this week?

The economic effects of this will be felt in mortgage,business and other borrowing rates. This will include governments many of whom have got used to cheap and indeed ultra-cheap credit.

 

 

 

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23 thoughts on “Rising bond yields are feeding into the real economy

  1. So, I guess the $64,000 question is, will the inevitable price/yield corrections be slow and steady or long delayed and followed a rapid, panicked overshoot?
    Also, any thoughts on potential time scales? Are things going to come to a head in a matter of months or is it more likely an issue for 2018/19 and beyond?

    • Hi theexengineer

      The main theme depends on the pick-up in inflation which these days mostly depends on the oil price. Unless it starts to fall again bond yields are going to look ever weaker in real terms in 2017. For everyone but the US then exchange-rates matter as well so if the recent rise above US $1.26 holds for the UK then a little of the edge will be taken off.

      In such a world it will be ever more difficult for central banks to argue for more QE at which point we will realise how low bond yields have really been in recent times.

    • Hi Foxy

      I would not be surprised if the central banks tried to give that another go as they really only seem to have plan A. For now we seem set to have a year of rising inflation ( especially in the UK due to the lower £) but of course if we had a period where the economy slowed then no doubt the siren calls would rise again.

      The drive to plan cash is part of the planning ahead raising the prospect if official interest-rates being able to go more negative next time around.

  2. Hi Shaun

    Great article as always. And this is where the central banks have failed us. They’re supposed to be independent. This involves making decisions which will be unpopular in the short-term,but benefit us all in the long-term. Instead they’ve bowed down to their mp overlords and constantly kicked the can down the road.

    In 2007 we could’ve had a short sharp recession. Clear the decks, let the indebted go under. instead they’ve given us ten years of misery and still not resolved the debt problem. Its got worse.

    We’ll reach the end of the road eventually. But who will the public blame. The central banks for their cowardice. Mp’s for taking the easy way out. Or themselves for bingeing on debt…..

    • Hi Anteos and thanks

      People rarely blame themselves so I would expect the anti-establishment wave to continue. After all the establishment does have quite a lot to answer. It looks from today’s developments that an Italian election is coming nearer which may well tell us some more about the general public mood.

  3. Hi Shaun
    Thank you for your latest views on the
    recurring subject of bond yields.

    “Also much less badged by central bankers buying bonds
    to do so makes government borrowing cheaper and
    therefore makes the independent central bank rather
    popular with politicians.”

    That sentence sums up how TPTB are likely to act, buy
    their (really our) debt so that us peasants won’t know or
    understand.

    Can you see them
    See right through them
    They have no shield
    No secrets to reveal.

    JRH

  4. Some of those plates are starting to wobble with the slowdown in spinning.
    Carney looks like he may end up with the choice between raising rates (collapse) or capital flight (implode).

    • Hi therrawbuzzin

      Mark Carney gave a speech this evening but as is common when he is on difficult ground he spoke about another subject which in this instance was FinTech. However he did tell us this.

      ” But first I should make a confession: I was a banker once.”

      He seems to have forgotten he still is.

      Happy Burns Night to you.

  5. Hi Shaun thanks again
    How long before the Big Bang? Timing is always impossible to predict.
    However if they were to allow market forces to apply in the bond markets Governments would struggle with the interest payments eg.UK £1.7T and the US $20T.
    So it’s QE to infinity but the debt is still increasing significantly ,there is no way out of this unless there is a debt jubilee which seems highly unlikely at this point.
    The trillions of global debt is being counted as assets on balance sheets,what happens if the dominoes start to fall losses will be unimaginable.
    Most people are oblivious to the risks in the financial world.

    • Hi Private Fraser

      Your logic of course means that governments will try to avoid market forces applying for a long as possible. The catch is that the rationale they have used so far which is inflation is below target is fast disappearing. So as Forbin says it may well be time to pull up a chair and eat some popcorn as we await their next move.

  6. Shaun,

    I can hear mark Carney now. Rather more QE is required than originally thought since the temporary respite following the Brexit vote is set to falter shortly. We need to plan ahead and ensure that Govt Bonds continue to find a market amongst the many international traders and confidence is maintained for the benefit of all particiants.

    Paul

    • Paul, if you are the Paul asking about a possible debt jubilee including private debt yesterday, then yes it would, as many private lenders to Sovereigns have themselves borrowed the money they have lent the Sovereign from elsewhere. There would be immense derivative problems with a debt jubilee so I would see it as each Government looking after ALL debt issued in it’s currency. Even then it would be very very messy with agonising financial pain and nerve endings wriggling and giving pain for decades to come, so this would be an absoloute last resort imo.

      The UK won’t falter this year imo due to strong narrow money growth and delayed Brexit although it’s real growth may slow as inflation gathers steam via a weaker pound against the dollar and slowly rising commodity prices allied to a potential increase in fiscal expenditure if Hammond is to be believed.

      • Noo2, Yes it was me. Thanks for your analysis, I saw 2017 as a year for change on all fronts and a destabilisation of the Status Quo everywhere. You suggest a slow decline under controlled administration which is very…. British.

        I have concerns about the UK property market starting a run, the MIRAs adjustment and extra stamp duty on BTL, along with slowing London, flat north and nervous pension cashers. Apparently there are excess of unlet “hoarded2 properties and un-occupied spaces indulged by the extending bubble. It won’t take much for a stampede, especially if a land value tax gets proposed.

        As you say, jubliee would be an extreme measure, perhaps with a proper property crash it may it become necessary.

        Do keep posting 🙂
        Paul

        • Thank you, I despise the English obsession with property as a source of “wealth” . I bought my house to live in not “to make money on”.

          That said, IMF research has shown that Housing market booms/busts usually, but not always, precede boom/bust in, firstly, financial markets and then the economy. I think it’s a confidence thing: people see their main asset that’s “as safe as houses” falling/rising in price, panic/have a confidence attack and reduce/increase spending, the rest is inevitable in a consumption led economy.

          I don’t see the property market the same way as most. To me you have the ownership and rented market which I guess most would agree with.

          Within the rented sector I see 3 landlord types:

          1. Professionals who do it for a living and have no or some debt (i.e. they own or almost own their rentals outright) – rate rises/decreases have little effect on them.

          2. Buy to let amateurs, usually highly leveraged – rate rises/decreases can have a very negative/positive effect on them mentally as well as financially as they have been told and believe, like Yazz, that “the only way is up” with buy to let and have no experience of bad tenants and long void periods (when a rental property is unrented) which can undermine confidence leading to panic decisions which are usually the wrong decisions and make for a volatile housing market.

          3. Reluctant landlords. They have inherited a house (usually with the mortgage paid off) in addition to their own or have moved jobs and still have their old house which is probably mortgaged. They have tried to sell the house but can’t, whilst the council tax and property insurance continues so they reluctantly move into the rental market to stem the loss they are suffering on the property. They too are largely unaffected by rate changes.

          MIRAS adjustment and stamp duty increases are likely to spook the second group if their belief in Yazz’s song becomes challenged.

          Unlet and unoccupied properties et al are, imo accounted for in great part by groups 1 and 3.. Group 1 is holding out (and can afford to hold out) for higher rentals whilst group 3 is still dithering whether to try renting out. Group 2 can’t really afford empty properties due to their leverage.

          Whilst empty properties are kept off the market thereby reducing supply this will provide price(rent) support for the existing stock of rental properties thereby helping out group 2.

          Currently, I see a slowing in price appreciation of houses but no depreciation in 2017 (although there will be regional differences and some regions like the North East, North West and Wales may experience small price falls).

          I am worried about 2018 and 2019 as Brexit nears as we have no knowledge of the outcome of negotiations. If the outcome starts looking bad then the housing market may well suffer followed by financial markets and finally the economy.

          Personally I would create a false housing market and freeze prices until a 3 bed semi could be purchased at 3 x average annual median income.

          London is it’s own micro market and I think you have to look at international events/economies to try to guess which way that market goes as most purchasers in London are foreign cash buyers clearly treating the property as a pure investment.

    • Hi Paul

      I would not be entirely surprised if some like Andy Haldane at the Bank of England would vote for that. The catch would be explaining which you are undertaking a policy to raise inflation when it was already above its target.

  7. Hi Shaun:

    “Chinese press reports that the PBoC have raised interest rate on one-year MLF loans by 10bps to 3.1% ( @SigmaSqwauk)”

    I did mention this to you on the 20th of this month – ” I believe the Chinese authorities have already commenced a tightening phase as Chinese narrow money growth has been collapsing from a high level since about August/September last year. My expectation is a Chinese rate increase in the next 3 months”

    and here we are already!

    I’ve put a reminder in my diary to re-examine my prediction from the 20th of January in December and post back here even if it turns out I’m be wrong!

    I am beginning to suspect that following the IMF talking about nominal growth (because it still helps with sovereign debt/interest (re)payment even if the rest of the country(ies) is/are impoverished) that Governments of the world may be beginning to take notice.
    Hammond has already talked about loosening fiscal (with potential inflationary characteristics 2 years down the road imo) and Trump is a prime candidate to create an inflation driven growth in the US with his policies, with little real growth to show, or even stagflation and the rest of the World may just decide to follow his example and the IMF’s advice from their fiscal Department as they all begin to surreptitiously tighten.

    • Sorry, I meant Trump’s loose fiscal will probably be leaned against by a tightening Fed and it is the interplay between the 2 that other countries will follow, the nest result of which will be tightening..

      • Good article in the FT today by Barry Eichgreen suggesting Trump does not understand how the overvalued dollar will impede virtually all of his agendas.

        I agree with you though in some bizarre dance it is likely that via IMF or forced tuneful music blaring from USA a status quo of sorts will be maintained as the other countries reluctantly stoke their inflation and move in time with monetary tightening.

        Is that a change to the status quo or everybody getting in line?

    • Hi Noo2

      The nominal growth argument has persisted throughout the credit crunch era. I have written several posts on nominal GDP targeting in my time on here and there are quite a few reasons for it being a bad idea. A major one is the one you quote, any gains are likely to be more inflation than growth driven.

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