This has been quite an extraordinary year in financial markets and we find that even the summer lull is being very active.Or rather it tried to go quiet and then kicked off again. The good news is that amongst a sea of indifference and sadly ignorance we have been on the case. What I am referring to is the surge in bond markets that has taken them to quite extraordinary heights and changes a large proportion of the financial landscape. So let’s get straight to it and where else to start but with President Trump.
Trade talks are continuing, and…..during the talks the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%…
So he now plans to expand his tariff trade war to pretty much everything Chine exports to the US. This has had the usual impact of lowering equity markets, strengthening the Yen ( into the 106s versus the US Dollar) and more importantly for our purposes today sending bond markets surging again.
This is our first lesson of the day which is that the financial markets version of economics 101 does still apply in some areas. What I mean by this is that sharp falls in equity markets still make bond markets rally. The logic such as it is comes from the fact that bonds pay a regular coupon as opposed to lower equity returns which makes the bonds more attractive. I am sure that many of you have spotted what Shakespeare would call the “rub” in this so for the moment let our analysis remain in the United States where there still are positive bond yields.
The situation now is that the ten-year Treasury Note now yields a mere 1.84% whereas yesterday I was reviewing a post US Federal Reserve 2,04%. The exact levels will change as this is a febrile volatile environment but the general picture has been singing along with Alicia Keys.
Oh baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’
FallI keep on
Fallin’
This has caught out US Federal Reserve Chair Jerome Powell as he was doing his best to pour cold water on the view that interest-rates are about to be chopped. In a sense this shows that whilst central banks have a lot of power they were accurately described by Hall and Oates.
You’re out of touch
Anticipation of the extra US $40 billion of bond purchases on their way via the (even earlier) ending of QT or Quantitative Tightening will have pushed the market higher on their own. But they found that The Donald was there with some petrol and a match. Oh and according to Market watch he may have just found another petrol can.
President Donald Trump on Friday will make an announcement on European Union trade at 1:45 p.m. Eastern, according to the White House’s daily guidance. Trump has threatened tariffs on European Union cars as well as food and alcohol, and plane makers Airbus AIR, -4.54% and Boeing BA, -2.02% have also been the source of trade tensions between the two sides.
So let me conclude the section on the world’s largest bond market with two points. Chair Powell thinks he is in charge but in reality a combination of President Trump and the markets are running rings around him, Next is that the real world economic effects of this will be cheaper fixed-rate mortgages and business borrowing as well as lower borrowing costs for the US government. Leaving us with a view that the Trump era is a curious combination of blazing away incoherently in the moment but also showing signs of an underlying plan as he gets lower bond yields for his fiscal expansionism.
Negativity
He was right by the way it is more today. Also as a nuance the amount of corporate debt that has a negative yield has passed the US $1 trillion mark. A nice little earner for some and of course as we look at the overall picture I find myself musing about future trends.
Glaciers melting in the dead of night
And the superstars sucked into the super massive
Super massive black hole
Super massive black hole
Super massive black hole
The UK
The situation here is remarkable in its own way. Even Bank of England Governor Mark Carney could not entirely blame Brexit for the situation.
Since May, global trade tensions have intensified, global activity has remained soft, and the perceived likelihood of a no-deal Brexit has increased significantly. These developments have led to substantial declines in market interest rates and a marked depreciation of sterling.
Let me give credit to Joumanna Bercetche of CNBC who asked a question about Forward Guidance. After all Governor Carney has been giving Forward Guidance about interest-rate rises through the period that bond yields have plunged. Sadly he deployed the tactic of answering a question he would have preferred to have been asked, gambling that no-one in the press corps would have the chutzpah to point that out.
This matters because we find ourselves in an extraordinary situation with the five-year yield at a mere 0.33% this morning. Firstly let me point out the ongoing excellence of the comments section of this blog as Kevin suggested we would reach 0.4% a while back when such views were deeply unfashionable elsewhere. Next this should be impacting on fixed-rate mortgages as banks can fund very cheaply in this area now although so far there seems to have been little sign of this, so perhaps the banks are keeping the change here for themselves. Finally the UK can borrow ever more cheaply an issue which the media and the “think-tanks” keep ignoring as they pontificate over whether the government can spend more? Of course it can at these yields! Whether that is a good idea or whether it will spend it wisely are different matters.
There is a curious situation in the UK yield curve where the five year yield at 0.33% is below the two-year at 0.42% and the ten-year at 0.55% so let me explain it. We have a 0.75% Bank Rate which in explicit terms only applies overnight but let us more loosely say until the next Bank of England meeting. That has more of an influence on the two-year which is why it is higher. But even so it is some 0.33% below the Bank Rate.
Before I move on let me point out how extraordinary this is by reminding everyone that the last time we were here the Bank of England was involved in making some £60 billion of purchases at almost any price. In fact as it wanted lower Gilt yields back then it wanted to pay more. How insane in the membrane is that?
Comment
It is rather kind of financial markets to help me out here as just as I start typing this section they reach a threshold.
German bonds at -0.5% yield Klaxon.
The benchmark ten-year yield is already telling us what it expects the new ECB deposit rate to be. Or perhaps I should say the maximum as the two-year is at -0.78%.
Let me resume my insane in the membrane theme with this.
Putting it another way here is Bloomberg.
Borrowing costs for house purchases and companies in Italy are at an all-time low
Politicians must wish they had thought of the idea of creating “independent” central banks even earlier than they did……
What could go wrong? Well let me start you off, with a quarterly and annual economic growth rate of 0% it does not seem to be doing Italy much good.
Notayesmanseconomics's Blog 
Well Boris can fund his ‘hard no deal’ brexit without a problem. Whether he should is another matter. I just typed the ‘no’ the other way round to start with, perhaps I should have left it as it was?
well this is politics , which Shaun stays away from
but me? does anyone know if Boris is good at poker?
I don’t believe anyone knows the true impact of a WTO brexit will be until it’s seen in the rear view mirror after 2 years.
Forbin
PS: have to make popcorn supplies are all good 😉
Hello Shaun,
re: “growth rate of 0% it does not seem to be doing Italy much good.”
in the round we should not expect growth at all – after all that’s what “sustainable ” means ….
it’s Greenpeace heaven…
Smile its the weekend !
Forbin
Hi Forbin
Don’t worry if the Ashes test remains like this I will be enjoying the weekend. There is even a Surrey lad Rory Burns leading our batting as I grew up just down the (camberwell new) road from the Oval 🙂
As to Italy in some ways it is a dream for the greens but also being Italy I doubt it works like that!
Shaun, Mario has been on the phone and has asked me to pass on this comment: “just imagine how bad their economy would be if rates were positive”.
Hi DD
Actually their economy was better when they had positive interest-rates. Whilst it was not stellar hence my girlfriend in a coma theme it was better than what they have with all time lows.
If he calls again please ask him how the Draghi Laws for the Italian banks worked out?
Great blog as usual, Shaun, and thanks for reminding us how prescient Kevin was in forecasting five-year bond yields.
At the Inflation Report press conference one of the journos, I believe it was Faisal Islam, asked what impact a major drop in sterling would have on inflation, and whether it might cause real wages to fall. Carney had Ben Broadbent take the question and he said that any impact on inflation would not likely be enough to keep real wages from increasing. It put me in mind of his testimony to the House of Commons Public Administration and Constitutional Affairs Committee on March 26, 2019, relating to the governance of public statistics. Among other things a dip in the value of sterling following the UK crashing out of Brexit should cause a spike in prices of package holiday trips. Yet due to the ersatz seasonal weighting formula used it will take a long time to register in the inflation rate. We will have to wait to February 2020, and the release of the January 2020 update, to have a measure that means anything, and then the annual inflation rate will tell us, not how much holiday trip prices rose between January 2019 and January 2020, but how much they rose between the fiscal year ending in January 2019 and the fiscal year ending in January 2020, so even this annual inflation rate lags the rest of the CPI, and will dampen the spike caused by the fall in sterling. Broadbent maintained, against the plain evidence of its terms of reference, that the quarterly meetings of the Tetrapartite Group are meant to influence the ONS in its decisions on concepts and methods, that they are just fact-finding missions. (The group includes members from the Bank of England, HM Treasury, the OBR and Prices Division of ONS.) Yet there has been no movement on changing the discredited formula for holidays, even though this was identified as a priority for ONS in the January 2015 Johnson report on consumer price indices. There was no mention of it in the Bean report, which raises the suspicion that the Bank of England finds the lag convenient for its own purposes, even if it cannot be justified, and wants to rag the puck on replacing it with something more useful. We have no agenda or minutes for their meetings so don’t know what they talk about, although Broadbent did let slip that air fares had recently been discussed, which would be an important component of holiday trips.
I doubt that Broadbent endears himself to his central bank colleagues serving on the Tetrapartite Group by sniffing that they are at a “relatively junior level”. The terms of reference for the Tetrapartite Group only identify participants by title, not by name, but the first of the two Bank of England participants would appear to be Sandra Batten, Senior Economist, Structural Economic Analysis Division. The lovely Ms Batten was educated at the LSE, so we know she got the best economics training imaginable, and her two most recent working papers were both on climate change. Far from being a non-entity, we may have located Mark Carney’s brain.
Re : “We have no agenda or minutes for their meetings so don’t know what they talk about,”
I know what they talked about at the end though ……..
Dessert cart, Joel Robuchon. Photo by Rosemary Nickel, Motivating Other Moms.