Was that the bond market tantrum of 2019?

Sometimes economics and financial markets provoke a wry smile. This morning has already provided an example of that as Germany’s statistics office tells us Germany exported 4.6% more in September than a year ago, so booming. Yes the same statistics office that told us yesterday that production was down by 4.3% in September so busting if there is such a word. The last couple of months have given us another example of this do let me start by looking at one side of what has taken place.

QE expansion

We have seen two of the world’s major central banks take steps to expand their QE bond buying one explicitly and the other more implicitly. We looked at the European Central Bank or ECB only on Wednesday.

The Governing Council decided to restart net purchases under each constituent programme of the asset purchase programme (APP)……….. at a monthly pace of €20 billion as from 1 November 2019.

More implicitly have been the actions of the US Federal Reserve as it continues to struggle with the Repo crisis.

Based on these considerations, last Friday the FOMC announced that the Fed will be purchasing U.S. Treasury bills at least into the second quarter of next year.7 Specifically, the Desk announced an initial monthly pace of purchases of $60 billion.

That was John Williams of the New York Fed who added this interesting bit.

These permanent purchases

Also there is this.

In concert with these purchases, the FOMC announced that the Desk will continue temporary overnight and term open market operations at least through January of next year.

Maybe a hint that they think dome of this is year end US Dollar demand. But we find that the daily operations continue and at US $80.14 billion as of yesterday they continue on a grand scale. So the Treasury Bill purchases and fortnightly Repo’s have achieved what exactly?

If we move from the official denials that this is QE to looking at the balance sheet we see that it is back above 4 trillions dollars and rising. In fact it was US $4.02 trillion at the end of last month or around US $250 billion higher in this phase.

Bond Markets

You might think and indeed economics 101 would predict that bond markets would be surging and yields falling right now. But we have learnt that things are much more complex than that. Let me illustrate with the US ten-year Treasury Note. You might expect some sort of boost from the expansion of the balance sheet and the purchases of Treasury Bills. But no, the futures contact which nearly made 132 early last month is at 128 and a half now. At one point yesterday the yield looked like it might make 2% as there was quite a rout but some calm returned and it is 1.91% as I type this.

As an aside this is another reminder of the relative impotence of interest-rate cuts these days as if anything a trigger for yields rising was the US interest-rate cut last week. The Ivory Towers will be lost in the clouds yest again.

The situation is even more pronounced in the Euro area where actual purchases have been ongoing for a week now. However in line with our buy the rumour and sell the fact theme we see that the German bond market has fallen a fair bit. In mid-August the benchmark ten-year yield went below -0.7% whereas now it is -0.26%. So Germany is still being paid to borrow at that maturity but considerably less. Indeed at the thirty-year maturity they do have to pay something albeit not very much ( 0.24%).

The UK

There have been a couple of consequences in the UK. The first I spotted in yesterday’s output from the Bank of England.

Mortgage rates and personal loan rates remain near
historical lows, with the rates on some fixed-rate mortgages continuing to fall over the past few months (Table 2.B).
Interest rates on credit cards have increased, although the effective rate paid by the average borrower has remained
stable, in part because of the past lengthening of interest-free periods.

Whilst this is true, if you are going to parade the knowledge of the absent-minded professor Ben Broadbent about foreign exchange options then you should be aware that as Todd Terry put it.

Something’s goin’ on

The five-year Gilt yield has risen from a nadir of 0.22% to 0.52% so the ultra-low period of mortgage rates is on its way out should we stay here.

If we move to the fiscal policy space in the UK then we see that the message that we can borrow cheaply has arrived in the general election campaign.

Although debt stocks are high in many developed countries, debt service ratios are very low. The UK gross debt stock has doubled from 42 per cent of GDP in 1985 to 84 per cent of GDP today, yet debt interest service has halved, from 4 per cent of GDP to below 2 per cent over the same period. It has rarely been lower. A rule using the debt stock would argue for fiscal consolidation, whereas a debt service metric suggests there is ample room for fiscal expansion. Especially as market interest rates are extraordinarily low. (  FT Alphaville)

https://ftalphaville.ft.com/2019/11/06/1573068343000/Is-it-time-for-a-shift-in-fiscal-rules–/

I have avoided the political promises which peak I think with the Greens suggestion of an extra £100 billion a year. But the Toby Nangle and Neville Hill proposal above has strengths and has similarities to what I have suggested here for some time. But I think it needs to come with some way of locking the debt costs in, so if you borrow more because it is cheap you borrow for fifty years and not five. It reinforces my suggestion of the 27th of June that the UK should issue some 100 year Gilts.

Comment

There is a fair bit to consider here and let me start with the borrow whilst it is still cheap theme. There are issues as highlighted by this from Francine Lacqua of Bloomberg.

London’s Elizabeth line has been delayed by a year, and will require extra funding, according to TfL

For those unaware this was called Crossrail ( renaming is often a warning sign) which will be a welcome addition to the London transport infrastructure combing elements of The Tube with the railways. But it gets ever later and more expensive.

There was also some irony as regards the Bank of England as in response to the sole decent question at its presser yesterday (from Joumanna Bercetche of CNBC) Governor Carney effectively suggested the next rate move would be down not up. Yet Gilt yields rose.

Next comes the issue of whether this is a sea-change or just part of the normal ebb and flow of financial markets? We will find out more this afternoon as we wait to see if there were more than just singed fingers in the German bond market for example or whether some were stopped out? After all reporting you had taken negative yield and a capital loss poses more than a few questions about your competence. Even the most credulous will now know it is not a one-way bet but on the other hand if you are expecting QE4 to come down the New York slipway then you can place your bets at much better levels than before.

8 thoughts on “Was that the bond market tantrum of 2019?

  1. Hi Shaun, prescient points today. Like everything a else in life. It looks greener over there until you get there. I would be entertained to see the borrowing start in earnest only to find Govt debt rates and IR base levels escalate to 3-5% thereby nullifing the opportunity and triggering question marks over the whole viability of debt, public and private.

    I think we can see MMT justifications following very quickly afterwards.

    P.S. Flying to Italy this morning for a 5star holiday surfing near Livorno. I will report local economy next week 😉

    • Hi Paul C

      I think that the current structure would have to be overthrown before we would get interest-rates like that. Your levels do have me wondering when we would see QE4 in the US? A solid move over 2% for the ten-tear? That would certainly get President Trump tweeting….

      Enjoy Italy, it is a lovely country.

    • Hi Chris

      Well it continues to lighten the load of its MBS book as it fell by US $1.7 billion in the last week of October whilst its holdings of Treasury Bonds rose and Treasury Bills rose a lot ( US $15 billion).

      As I have pointed out many times central banks should plan a way out of anything they do before they do it. But it gets ever plainer that they do not.

  2. Shaun

    Both parties particularly Conservative & Labour going on a spending spree in one way or another Jarvis saying we can borrow at negative interest rates right now.

    Over what time scale would you think that would be and what would happen at the end of the period?

    If debt is not paid back which presumably it wouldn’t be with a world downtrend would they just have to seek new borrowing at the prevailing rates available?

    There is nothing wrong in continual borrowing on if you are certain at some stage you can producer more to repay the debt but if you cannot produce enough to repay the debts there would have to be defaults at some stage.

    Lastly has there ever been a time when we had a situation similar to this? I haven’t seen a situation like this before in my near 70 years and don’t know what the global situation was in the wall street crash.

    But even that cannot be compared to the financial crisis of 2008 as we rely more on global trade now more than we have ever done before.

    I just wonder if the US can see things brewing up globally and the risks they pose and that is one reason why the US would prefer to become more self reliant.

    • Hi Peter

      He must mean real ( adjusted for inflation ) yields which they all are. The only swerve is that once we get a year or two ahead we have no idea what inflation will be so we are using actual inflation as shown by the tweet below.

      It is good to see BBC Newsnight using the RPI as its inflation measure and I have been pointing this out on social media. I hope Ben does not get called in by HM Treasury for some “re-education”.

  3. Hello Shaun,

    I have a sneaking suspicion that who ever gets in and then tries to get this money will find the rates have suddenly gone up !

    Forbin

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