Current bond yields imply a depressing view of the world economy

Let me welcome you all to 2019 as we advance on another new year. I hope that it will be a good one for all of you. As I look at financial markets there has been a development which in isolation is good news. This is that the US ten-year Treasury Bond yield is now 2.67%. That is good news for US taxpayers as their government can borrow more cheaply in spite of the current shut down of part of it and good news for US mortgage borrowers as it feed into fixed-rate borrowing costs. It compares to this situation which I looked at back on the 6th of December.

Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises.

I will look at why in a moment but let us now shift to the Wall Street Journal for another comparison.

The yield closed Monday at 2.68%, up from the 2.41% where it ended 2017.

The pattern is described by the WSJ below.

The yield on the benchmark 10-year Treasury note—which moves inversely to price and helps set borrowing costs for consumers and businesses around the world—climbed higher at the start of 2018 as stocks rose and the dollar weakened. Investors were content to look past geopolitical tensions, and bonds’ fixed rates, given expectations for a soaring profits and economic growth……..Now, the yield has retreated from multiyear highs hit in November, falling below 3%

The pattern was that the ten-year Treasury Bond rose to 3.26% and you may recall that there were forecasts of it going above 4% at that time. To be fair “bond king” ( CNBC) Jeffrey Gundlach was looking at the thirty-year yield but that has just dipped below 3% today in a different big figure move. Back in July the St. Louis Federal Reserve looked at why it thought US bond yields were rising.

The expected long-term inflation rate and the expected long-term real growth rate of the economy are the most important factors that influence long-term yields. If bond buyers expect higher inflation or higher real growth, they will expect higher interest rates in the future and thus will demand a higher yield on the bonds they buy today.

Central bankers love this sort of thing but I wish you the best of luck in figuring either out in reality! Especially after the past credit crunch driven decade. We can say that the US economy has performed better than its peers so there is a little light in the fog but the next bit to my mind is more important than we are told.

Bond yields also depend on the uncertainty about these factors, so the volatility of expected inflation and growth also influence long-bond yields, but these variables are harder to measure and have smaller effects.

Yes they are harder to measure but we should not use that as an excuse to say they have smaller effects just because that is all we can find. The period between when that was written in July and now shows us how powerful this can be if we look at the ch-ch-changes. Also this bit has not worn well.

The growth in expected future fiscal deficits is likely to have contributed to the rise in relative yields.

That was true but is even more true now an yet yields have fallen as I pointed out earlier. Financial markets pick and choose which factors are the most important at the time and I note the St.Louis Fed missed out the main driver of bond yields in the modern era which is the impact of the policy of the Federal Reserve itself.

The international picture

I do agree with the St.Louis Fed on this point.

The international yields usually, but not always, move together. (  the U.K., Canada, Germany, Japan, Switzerland)

The next bit is awkward for them to analyse as we are back to the impact of central banking policies again. So Germany for instance has seen its bond yields continue to be driven lower by purchases made by the European Central Bank or ECB which have just stopped. But we see that the ten-year German bund yields a mere 0.18% as I type this. Again in isolation that is a benefit for German taxpayers and borrowers but there is also a problem which is highlighted by this from the Markit PMI from this morning.

The headline IHS Markit/BME Germany Manufacturing
PMI – a single-figure snapshot of the performance of the
manufacturing economy – slipped to 51.5 in December,
down from 51.8 in November and its lowest reading since
March 2016. It marked the eleventh time that the index had
fallen in 2018, down from a record high in December 2017.

The German economy has hit a weak phase and this includes the 0.2% fall in GDP in the third quarter of 2018. But the problem is that long-term it has benefited from a lower currency via replacing the Deutschmark with the Euro and in more recent times it has benefited from low and then negative interest-rates. What else is there? Also regular readers who have followed my regular updates on the weakening money supply data in the Euro area may have a wry smile at this.

but the extent of the slowdown has been somewhat of a surprise.

Central banking policy

This has changed although as ever the rhetoric is in the wrong direction. From Reuters.

The most prominent hawk on the European Central Bank’s board still expects an interest rate hike in 2019 but concedes that this will depend on inflation data in the first half of the year………Sabine Lautenschlaeger, a German who has long called for the ECB to tighten its ultra-loose policy, still hopes for a move next year if data allows.

Actually as we have looked at above the data would be considered grounds for considering an interest-rate cut if the ECB deposit rate was not already -0.4%. In my opinion we cannot completely rule out a rise because just like we saw in Sweden before Christmas there could be an attempt to get back to 0% before things get any worse. But it would be an example of what in itself being a good idea being done with bad timing which means it should not happen.

If we move back to the US the simple fact is that the interest-rate rise of a couple of weeks ago may be the last one. Also due to technical reasons ( the amount of Quantitative Tightening or QT depends on maturing bonds) the bond sales will slow in 2019 anyway, but in a slow down there will be pressure for QE4 to head down the slipway.

Comment

What started as good news leads to a more uncomfortable picture as we note that the real shift has been in economic data. This as we looked at last year got worse as we saw a slow down in monetary data lead to weaker economies around the world. This morning has seen another sign of this. From CNBC.

The moves in pre-market trade come after a private sector survey showed manufacturing activity in the world’s second-largest economy contracted for the first time in 19 months. China’s Markit Manufacturing Purchasing Managers’ Index (PMI) for December dipped to 49.7 from 50.2 in November.

This added to the news that auto sales had fallen by 16% in November in China. We have also seen this from Chris Williamson on the Markit PMI data.

manufacturing indicates that last 3 months of 2018 saw the worst factory output growth since the Q2 2013, with firms having to eat into backorders to sustain production levels. Some temporary factors evident but trend looks worryingly weak

Stock markets have led this and I note that they are lower today although we need to note the extraordinary ups and downs of the holiday period. Also there is the role of the price of crude oil which also was volatile but overall has been falling. It supports bond prices and reduces bond yields but affecting inflation projections and also signalling a potentially weaker economy.

So there you have it as we find that what looks like good news is a signal for bad economic trends. It does show markets responding in the way that they should. The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!” We already start with trillions of bonds with a negative yield so what can be gained?

16 thoughts on “Current bond yields imply a depressing view of the world economy

  1. Good timing in every way Shaun just in time for my morning coffee and biscuits plus Sweden has just released it’s PMI’s and it’s at the lowest since 2016. Good luck to Riksbank increasing those interest rates!

    As to bonds we know two things there is no market for them and their natural rate is zero. The so called ‘bondkings’ make such terrible predictions because they still think the Gold Standard exists, how do they get away with it? It really is time to abolish bonds for all except the Pensions and Insurance industry, they serve no purpose anymore.

    • Hi Bill

      You did better than me as it was only coffee at Core Finance earlier. As to Sweden I remember pointing out on the 20th of last month that their move was a mistake. In terms of the detail here is Nordea on the PMI you mention.

      “The manufacturing PMI declined to 52.0 in December.

      The PMI report suggests that the manufacturing industry ended 2018 on a weak note. The PMI stood at 52 in December, down from 55.4 in November. All sub-indices declined.

      We note that the sub-index for prices continued to decline in line with the drop for metal prices on the world market, reflecting global slowdown and low price pressures.

      The time series for the PMI was revised (new seasonal adjustment). For instance, the November reading was lowered to 55.4 from 56.7.

      All in all, the conclusion is obvious – there is a slowdown in the manufacturing industry. The only positive news are that the orders-to-inventory ratio as well as the OECD leading indicator don’t suggest any further downturn in the PMI in the near term.”

  2. Happy New Year, Shaun.
    As you know, I am no expert in any of this stuff, but it does seem to me that the US used a period of strong growth to increase interest rates and end QE (and, indeed, start QT), The ECB timing all looks wrong to me. It is ending QE at the very moment that growth is stalling and has not increased rates for years and seems more boxed in than the USA now.
    For what it is worth, I predict:
    1. Low Euro inflation
    2. No interest rate rises while Draghi is around
    3. More ECB QE.
    I also see quite choppy political waters ahead, with:
    1. Italy, as ever, looking pretty weak
    2. Macron’s efforts at reform have stalled and budget discipline has disappeared
    3. The European Parliament elections are coming up and may well increase anti-EU parties, with potentially an increase in the number of countries refusing to accept the deficit limits under the growth and stability pact.
    The ECB may then be faced with trying to apply a “one size fits all” policy to a set of countries whose fiscal stance differs substantially and where efforts to control them could backfire into even greater euro scepticism.
    We live in interesting times.

    • Hi James and Happy New Year to you as well

      The continual media discussion about an ECB interest-rate rise has three problems. If you listen to Mario Draghi in the press conferences it is clear he has no intention of raising which gets us to the autumn.Also the Euro area economy has been slowing which will only reinforce Mario’s lack of enthusiasm. Looking ahead the monetary data suggests it will be an uninspiring first half to 2019. So your point 2 has been hammered in by more than a few nails.

      More likely is a restart of QE but that has a couple of issues.

      a) They will want to wait for a while as otherwise it would be rather embarrassing.
      b) In some countries ( Germany for one) there are not so many bonds left to buy.

      So another large-scale TLTRO may well be on the cards.

  3. Hi Shaun

    Happy New Year to you and all contributors here.

    In all honesty this seems to me a continuance of what we’ve had for the last ten years: manipulated markets; tepid growth driven by debt; can kicking to postpone the denoument and high and increasing debt levels in both the public and private sphere.

    As mentioned above QE appears to be necessary to keep borrowing costs down because otherwise rates would go up and the Ponzi would be punctured and we would have total collapse. It’s quite clear that policy makers cannot face up to the problems they have caused over the past thirty years and they have effectively destroyed the markets in order to keep the whole dysfunctional structure afloat.

    An economic downturn will cause severe problems for the Eurozone and may hasten its end quite substantially. Although the original designers knew the structure was faulty they envisaged a crisis would call forth measures for much closer integration and make the Euro much more sustainable. However, and as you imply, the Euro is an economic divergence machine and there is much less appetite politically now than two years ago for closer integration and this is likely to get worse not better.

    • Excellent summary, I could not have summed it up better. Maxxed out on debt and now we have the January Sales. I noticed a renewed interest in gambling in the UK to cure the prole’s debt problems… just one more lottery ticket or premium rate call simple answer wins phone in.

      It seems that the entire world is “stalling out”. Some wags even suggested Brexit could be a black swan in 2019. China is also maxxed out on debt. Junks bonds are causing issues in the USA with rate rises. Europe has its elections and as you underline only one productive economy.

      I think Britain will be managing expectations the media message, culturing stories to deflect focus from the economic mess we have made. Did you know that children are eating too much sugar… also that the police fly drones near airports, and there are people in boats…

      • managing expectations the media message ?

        along the same lines as a couple of tourists died to having neck injuries in Morocco? * as reported by BBC ……

        Forbin.

        * deepest sympathies and my heart goes out to their parents , just absolutely horrific

        ** does the BBC have any reporters these days or is it all click-bait / citizen phone uploads?

  4. Off topic, but did you see that the ECB has had to take over the running of an Italian bank (Carige) today. A nice start to the year for the ECB…

    • “The ECB said the decision to provide temporary administration is an early
      intervention measure aimed at ensuring continuity and pursuing the objectives of
      a strategic plan”
      Perhaps Deutsche Bank can help, with their 10 year experience of trying to
      find a workable strategic plan, erm :o)

      • You have to laugh at this. I mean, do you really believe
        1. That it’s temporary
        2. That it’s early
        3. That it’s part of a strategic plan?

        • yah, double speak !

          1, permanent
          2, too late
          3, making up as we go along……

          oh the forth

          4, no one could have foreseen this …. aka bleeding obvious to everyone else ….

          forbin

  5. Hello Shaun,

    so weaker results – and we’re still on emergency IR .

    the long emergency continues – to about 2038 I predict ( uh oh stuck my neck out there! )

    unless there’s a series of major events ….. those unknown “unknowns” are always tricky!

    can we the tax payer afford to save the TBTF Banks again ? ( nod to James’s post )

    Happy New year to one and all – keep yer tin hats ready and your bug-out bag handy !

    forbin

  6. Treason May’s Brexit deal is designed for one purpose; to save the EU.
    Whilst this may not be totally unwise economically, (we are likely to best with a thriving EU, inside or out) the fact is that the Brexit-voting UK taxpayer does not care to pay for its good health.
    Given the unlikelihood of her plan getting through parliament, would anyone agree that the alternatives do EU no good.
    Hard Brexit means no £39bn payout (we contributed to the budget for measures passed before we joined, so that is not unfair) and RoI goes POP!
    No Brexit means UK brought to a standstill by civil unrest (at the very least) and RoI goes POP!
    Remember RoI’s total debt (public and private) = €1.67 trn and that, even at very low interest rates takes some servicing.
    Default on that would, I assume, mean, “Game Over” for the European banking system?
    Anyway, that’s how I see things, but I’d be grateful if those of you with more knowledge than I would point out my errors.

  7. Happy New Year ?
    The utter refusal by the ruling elite to admit that the monetary system initiated temporarily by Richard ‘I am not a crook’Nixon on August 15th 1971 requires to be reset is at the root of the crisis.
    The debt has been expanding exponentially since then the money system is based on debt which is money creation by private banks.
    What they are doing is kicking the can down the road but eventually maybe soon maybe 20 years from now the debt will overwhelm and destroy the economic system.
    The banks have created bubbles in property,stock markets and debt markets wealth can only be created by growing or making something not through financialisationof the economy.

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