What is driving bond yields these days?

Yesterday brought us an example of how the military dictum of the best place to hide something is to put it in full view has seeped into economics. Let me show you what I mean with this from @LiveSquawk.

HSBC Cuts German 10-Year Bond Yield Forecast To 0.40% By End-2018 From 0.75% Previously, Cites Growth Worries, German Political Tensions Among Reasons – RTRS

Apart from the obvious humour element as these forecasts come and go like tumbleweed on a windy day there is the issue of how low this is. Actually if we move from fantasy forecasts to reality we find an even lower number as the ten-year yield is in fact 0.34% as I type this. This poses an issue to me on a basic level as we have gone through a period of extreme instability and yet this yield implies exactly the reverse.

Another way of looking at this is to apply the metrics that in my past have been used to measure such matters. For example you could look at economic growth.

Economic Growth

The German economy continued to grow also at the beginning of the year, though at a slower pace……. the gross domestic product (GDP) increased 0.3% – upon price, seasonal and calendar adjustment – in the first quarter of 2018 compared with the fourth quarter of 2017. This is the 15th quarter-on-quarter growth in a row, contributing to the longest upswing phase since 1991. Last year, GDP growth rates were higher (+0.7% in the third quarter and +0.6% in the fourth quarter of 2017). ( Destatis)

If we look at the situation we see that the economy is growing so that is not the issue and furthermore it has been growing for a sustained period so that drops out as a cause too. Yes economic growth has slowed but even if you assume that for the year you get ~1.2% and it has been 2.3% over the past year. Thus if you could you would invest any funds you had in an economic growth feature which no doubt the Ivory Towers are packed with! Of course it is not so easy in the real world.

So we move on with an uncomfortable feeling and not just be cause we are abandoning and old metric. There is the issue that we may be missing something. Was the credit crunch such a shock that we have yet to recover? Putting it another way if Forbin’s Rule is right and 2% recorded growth is in fact 0% for the ordinary person things fall back towards being in line.

Inflation

Another route is to use inflation to give us a real yield. This is much more difficult in practice than theory but let us set off.

 The inflation rate in Germany as measured by the consumer price index is expected to be 2.1% in June 2018. ( Destatis)

So on a basic look we have a negative real yield of the order of -1.7% which again implies an expectation of bad news and frankly more than just a recession. Much more awkward is trying to figure out what inflation will be for the next ten years.

This assessment is also broadly reflected in the June 2018 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.7% in 2018, 2019 and 2020.  ( ECB President Draghi)

That still leaves us quite a few years short and after its poor track record who has any faith that the ECB forecast above will be correct? The credit crunch era has been unpredictable in this area too with the exception of asset prices. But barring an oil price shock or the like real yields look set to be heavily negative for some time to come. This was sort of confirmed by Peter Praet of the ECB on Tuesday although central bankers always tell us this right up to and sometimes including the point at which it is obviously ridiculous.

well-anchored, longer-term inflation expectations,

 

The sum of short-term interest-rates

In many ways this seems too good to be true as an explanation as what will short-term interest-rates be in 2024 for example? But actually maybe it is the best answer of all. If like me you believe that President Draghi has no intention at all of raising interest-rates on his watch then we are looking at a -0.4% deposit rate until the autumn of 2019 as a minimum. Here we get a drag on bond yields for the forseeable future and what if there was a recession and another cut?

QE

This has been a large player and with all the recent rumours or as they are called now “sauces” about a European Operation Twist it will continue. For newer readers this involves the ECB slowing and then stopping new purchases but maintaining the existing stock of bonds. As the stock of German Bunds is just under 492 billion Euros that is a tidy sum especially if we note that Germany has been running a fiscal surplus reducing the potential supply. But as Bunds mature the ECB will be along to roll its share of the maturity into new bonds. Whilst it is far from the only  player I do wonder if markets are happy to let it pay an inflated price for its purchases.

Exchange Rate

This is a factor that usually applies to foreign investors. They mostly buy foreign bonds because they think the exchange rate will rise and in the past the wheels were oiled by the yield from the bond. Of course the latter is a moot point in the German bond market as for quite a few years out you pay rather than receive and even ten-years out you get very little.

Another category is where investors pile into perceived safe havens and like London property the German bond market has been one of this. If you are running from a perceived calamity then security really matters and in this instance getting a piece of paper from the German Treasury can be seen as supplying that need. In an irony considering the security aspect this is rather unstable to say the least but in practice it has worked at least so far.

Comment

We find that expectations of short-term interest-rates seem to be the main and at times the only player in town. An example of this has been provided in my country the UK only 30 minutes or so ago.

Britain’s economic strength shows a need for higher interest rates, Mark Carney says. ( Bloomberg)

Mark Carney prepares ground for August interest rate hike from Bank of England with ‘confident’ economic view ( The Independent).

The problem for the unreliable boyfriend who cried wolf is that he was at this game as recently as May and has been consistently doing so since June 2014. Thus we find that with the UK Gilt future unchanged on the day that such jawboning is treated with a yawn and the ten-year yield is 1.28%. If you look at the UK inflation trajectory and performance than remains solidly in negative territory. So the view here is that even if he does do something which would be quite a change after 4 years of hot air he would be as likely to reverse it as do any more.

The theory has some success in the US as well. We have seen rises in the official interest-rate and more seem to be on the way. The intriguing part of the response is that US yields seem to be giving us a cap of around 3% for all of this. Even the reality of the Trump tax cuts and fiscal expansionism does not seem to have changed this.

Is everything based on the short-term now?

As to why this all matters well they are what drive the cost of fixed-rate mortgages and longer term business lending as well as what is costs governments to borrow.

 

 

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16 thoughts on “What is driving bond yields these days?

  1. Shaun, I agree it is a condundrum. Current inflation and future yields simply do not add-up. Short termism in everything, with the expectation that the upset is always “next year” but never 10 years away. The 10 year window seems so far away I guess that since we only make plans up until Brexit then how the heck can we price for 10 years. away And the Brexit deadline just months away, prepapration is not going that well.

    I am certainly waiting personally before I decide my next career move. I guess everyone is standing water, financially and decision wise now.

    • Brexit preparation is going excellently.
      If the cabinet cannot agree a deal, then the EU cannot agree a deal, and, by far the best deal for the ordinary British person, is no deal.

  2. Excellent as always Shaun. As I understand the workings of the MPC, the chairman has the casting vote and he is now indicating his intention to vote for an increase in August (notwithstanding his unreliable boyfriend-ness). It seems therefore that we are looking for just one more vote from the remaining committee members – any pointers?

    M44KGW

    • Hi M44KGW

      You are raising an issue that the MPC was constructed to prevent. What I mean by that is with 9 members you will get an odd number on any yes or no vote. Whilst someone theoretically could abstain the danger of a draw and a casting vote comes at times when for whatever reason we are down to only 8. Also the internal members of which there are 4 apart from the Governor nearly always vote with him ( I only recall one occasion when Mervyn King lost his “team”). As one has gone already to the dark side ( Andy Haldane) that means 3 are likely to shift with the Governor, So we could go from 3-6 to 7-2 at which point seeing the backbone shown in the past it could even be 9-0.

      Staying with your view then if you made me pick Broadbent would be the one. Vlieghe blows with the wind as well.

      Don’t forget the Unreliable Boyfriend issue though……

      • The unreliable boyfriend is now saying that England winning the World Cup would be a great boost for the economy – and presumably produce a rate rise.

        So, that’s it – England to lose to Croatia in the semis and no rate rise in August.

  3. I think that the extraordinarily low yields are a reflection of the widely held belief that:
    1. The banks are still bust;
    2. An interest rate rise will kill them and the assets on which their loans are secured;
    3. The ECB will not allow 2 to happen;
    4. Therefore there is no point in hanging on for better rates, as they won’t happen.
    I think that the US was and is ahead of us in this. The banks were cleaned up more and earlier and the rates have begun to rise.

    • Hi James

      Yes that is one way of putting it as the precious is always at the forefront of their thoughts. The Fed seems set on course to carry on.

      “Policymakers generally agreed recent economic data showed a strong economy that was evolving in line with their expectations.” ( Reuters)

      We should have been able to follow that. Not as much as we are much more linked to Europe but say half of it. Yet in spite of his speech earlier Governor Carney has yet to convince me he intends to move at all. The boy keeps crying wolf.

  4. This raises more questions than answers at the moment:

    If the economy is really doing well why is personal debt still rising?

    Furthermore why did the BOE only a day ago warn that high household debt poses a risk to the “UK’s financial stability”!

    https://www.independent.co.uk/news/business/news/uk-debt-hiddden-from-partner-credit-cards-personal-loans-direct-line-survey-a8429391.html

    In simple terms the comments coming from the BOE don’t make any sense whatsoever to a mere mortal human being like myself.

    All I can see at the moment is sky high asset values particularly in housing, and lots of equity release at that, plus many brits benefitted from handy downs from bank of mum and dad and not to mention all those millions that the bank paid out in compensation for miss-selling.

    Now I could go further and talk about dodgy whiplash claims as well which may have boosted GDP over many years but will leave that one out for the moment.

    • Notwithstanding more personal debt increasing the over 55’s debt among retirees has risen by about a third.

      http://www.financialreporter.co.uk/later-life/unsecured-debt-amongst-retirees-soars-by-a-third.html

      Sone of the debt which retirees are accumulating is probably being used to encourage their young to jump on the property bandwagon to help inflate property prices further!

      When will it all end I say?

      Probably in tears and another recession sooner than later and a reality check!

      One cannot live beyond ones means and if one does that it will come to no good!

        • Evidently Carney thinks so hence a quick change of stance within a 24 hour period.

          Not precisely certain what mind blowing statistics he is relying upon that have come to mind the last 24 hours.

          All I can see at the moment is more and more warnings on BREXIT and lots of sales of ice cream and sun cream lately, but I wouldn’t have thought they would have boosted the economy that much.

          Of more concern would be the amount of people going off on a “sicky” to get their yearly allowance while the sun lasts, and the damage that is doing to the UK economy!

  5. Hi Shaun,

    Yes! The Credit Crunch was such as shock that we have yet to recover. (IMHO).
    Otherwise the base rate would be higher than .5%; and growth would be higher; and wages would be higher; and debt would be lower; and inflation would be higher and the referendum result might have been different; and we wouldn’t be discussing all these funny numbers; and so on…..

    The answer from some people in ivory towers of course could be ‘no’ simply because they have an different definition of ‘recover’.

      • We should be grateful it’s not worse Shaun.
        This from the BBC today reminded me I should have included productivity in the list —
        “ UK productivity shrank in the first quarter of the year and continues to lag rates achieved before the financial crisis in 2008, figures show.
        The Office for National Statistics said productivity fell by 0.4% compared to the final quarter of last year.
        It rose by 0.9% compared to the first three months of 2017.
        However, the ONS said it remains below the average pre-crisis growth rate of 2%, suggesting that the “‘productivity puzzle’ remains unsolved”.
        Productivity – as measured by the amount of work produced per working hour – is the main driver of long-term economic growth and higher living standards.
        However, growth has been flat over the past decade as the UK economy has recovered from the downturn triggered by the financial crisis.”

        …… perhaps a clue to the puzzle is in the last sentence.

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