What are the consequences of bond yields rising further?

This week has brought an unusual development for the credit crunch era. Let me illustrate with an example of the reverse and indeed what we have come to regard as the new normal from last week.

AMSTERDAM, Nov 5 (Reuters) – Italy’s five-year bond yield turned negative for the first time on Thursday as uncertainty from the U.S. election supported government bonds in Europe.

Prima facie that seems insane but of course as I will explain later it is more complicated than that. That is for best when we add in this from Marketwatch on Monday.

Investors now pay Greece for the privilege of owning its debt, an incredible turnaround from its securities being the source of global financial instability a decade ago.

Greece’s three-year debt turned negative on Friday, and then the country received more good news after the surprise decision by Moody’s Investors Service on Friday night to upgrade the nation’s debt. The upgrade, from Ba3 from B1 previously, still leaves Greek debt in junk market territory, and three notches away from becoming investment grade.

The yield on Greek 10-year debt TMBMKGR-10Y, 0.834% fell 4 basis points to 0.77%. In 2012, the yield on Greek 10-year debt surpassed 35%.

Amazing in its own way and well done to investors who got their timing right in these markets. Although a large Grazie is due to Mario Draghi who set things in motion.

US Treasury Bonds

However there has been something of a contrary signal from the US bond market. There was a hint of something going on in what is called the Long Bond which is the thirty-year maturity. Some of you may recall at the height of the pandemic panic in financial markets in March the yield here dipped below 1%. This was driven by two factors.The first was a move to a perceived safe haven in times of trouble and US Treasury Bonds are AAA rated as well as being in the world’s reserve currency. Also there would have been some front-running of the expected bond buying or QE from the US Federal Reserve. It did indeed charge in like the US Cavalry with purchases at the peak of US $75 billion per day.

But around 2 weeks ago the mood music was rather different as the debate was then about whether the yield would break above the 1.6% level that market traders felt was significant. As the election results began to come in it did so and now we find it at 1.75%.

If we switch to the benchmark ten-year ( called the Treasury Note) we see a slightly delayed pattern but also a move higher. In fact it gave us a head fake as the initial response to the election was a rally leading to lower yields and we noted it at 0.72%. But there were ch-ch-changes on the way and now we see it is 0.96%. So perhaps on the cusp of what is called a big figure change should it make 1%.

Why does this matter?

The first reason is for the US economy itself and there is a direct line in from mortgage rates.

Over the course of the past few days, 10yr yields are up roughly 0.2%.  This time around, the mortgage market hasn’t been able to avoid taking its lumps with the average lender now quoting 30yr fixed rates that are 0.125% higher compared to last Thursday.    ( Mortgage Daily News)

The housing market has been juiced by ever lower and indeed record low mortgage rates up until now. The change will feed into other personal and corporate borrowing as well.

Next comes its role as the world’s biggest bond market with some US $21.1 billion and of course rising at play here. I will come back to the domestic issues but there is a worldwide role here.For example back in my days in the UK Gilt ( bond) market the beginning of the day was checking what the US market had done overnight before pricing in any UK changes. That theme will be in play around the world and in fact on spite of the Italian and Greek moves above we have seen it.

For the US there is the domestic issue of debt costs. These have been a pack of dogs that have not barked but with the increases in the size of the bond market and hence higher levels of borrowing and refinancing smaller moves now matter. We know that President Elect Biden wants to spend more and looked at this on the 5th of this month although there remains doubt over how much of it he will be able to get through what looks likely to be a Republican controlled Senate. Even before this here are the projections of the Congressional Budget Office.

Debt. As a result of those deficits, federal debt held by the public is projected to rise sharply, to 98 percent of GDP in 2020, compared with 79 percent at the end of 2019 and 35 percent in 2007, before the start of the previous recession. It would exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.

Best I think to take that as a broad sweep as there are a lot of moving parts in the equations used.

Yield Curve Control

This is, as you can see, not going so well! We have looked at the Japanese experience as recently as Monday and in the US it would be a case of recycling a wartime policy.

In early 1942, shortly after the United States declared war, the Fed effectively abdicated its responsibility for monetary policy despite its concern about inflation and focused instead on helping the Treasury finance the conflict. After a series of negotiations with the Treasury, the Fed agreed to peg the Treasury-bill yield at 0.375 percent, to cap the critical long-term government bond yield at 2.5 percent, and to limit all other government securities’ yields in a consistent manner.  ( Cleveland Fed)

The Long Bond yield is still quite some distance from the 2.5% of back then but as I have already explained the situation is I think more exposed now.

Oh and there was a concerning consequence to this.

The Treasury, however, did not wish to relinquish its control over Fed monetary policy and only acquiesced to small increases in short-term interest rates starting in July 1947, after inflation had been hovering around 18 percent for a year. The Treasury believed that it could not possibly finance its unprecedented levels of public debt at reasonable interest rates without the Fed’s continued participation in the government-securities market; in its view, only unrealistically high interest rates could coax enough private-sector savings to finance the debt.

Comment

Let me now switch to what we might expect if we had free markets. The extra borrowing we have looked at would be pushing yields higher. Another influence would be the fact the real ( after inflation) bond yields are heavily negative unless you think US inflation will be less than 1% per year for the next ten years. Even then it is not much of a return, especially compared to the 5% in one day some equity markets have just provided. The reality is that bond markets provide the prospect of capital gains rather than interest right now.

Also the modern era provides something very different from free markets as the US Federal Reserve will be thinking at what point will it intervene? Or to be more precise at what point will it do so on a larger scale as it is already buying some US $80 billion per month of US treasury bonds. It was not so long ago that such amounts were considered to be a lot. The path to Yield Curve Control may be via bond yield rises now followed by its response. So the real question is what level will they think is too much? This quickly becomes an estimate of what they think the US government can afford? As they have become an agent of fiscal policy again.

 

26 thoughts on “What are the consequences of bond yields rising further?

  1. Reminder: When you have something that there is a monopoly supplier of, there can never be a free-market in that thing.

    A currency issuing government never, ever needs to sell a bond. It can sell them as a service to savers, but being a monopoly supplier that has no requirement to sell, it has to either fix the quantity and let the price vary or fix the price and let quantity vary. If it wishes to, it could fix both price and quantity. None of these scenarios can ever be described as a ‘free market’.

    As for the Fed becoming an agent of fiscal policy “again”, when was it not?

    “The Federal Reserve Act of 1913 provides that the Federal Reserve Banks will act as fiscal agents and depositories of the United States when required to do so by the Secretary of the Treasury. As fiscal agents, the Reserve Banks support the Department of the Treasury with services related to the federal debt. For example, they receive bids for auctions of Treasury securities to finance the debt and issue the securi- ties in book-entry form. As depositories, the Reserve Banks maintain the Treasury’s account, accept depos- its of federal taxes and other federal agency receipts, and process checks and electronic payments drawn on the Treasury’s account.”

    • You speak of countries as if they are closed systems; developed economies are not, every one of them imports & exports, often a number of times between the raw material & finished product stages.
      As such, others fix the price, & that price varies with quantity, amongst other things, as, if a country has a certain “worth” & its currency doubles, then, all other things being equal, the value of the unit of currency will halve, outwith the boundaries of that country.
      A govt. can decree prices within its borders as the USSR did with the Rouble, but that does not equal fixing an exchange rate regardless of quantity.
      As for fixing a price, see Anthony Barber, Norman Lamont & Recep Tayyip Erdoğan.

    • Hello Robert,

      when the term ” fiscal” is used I beleive that it seems to mean different things to who ever is using it ( or thinks they do ) , if that makes any sense .

      If not, I’ll just pour my self another single malt

      Cheers All !

      Forbin

      • that quote was taken from “The Federal Reserve Banks as Fiscal Agents and Depositories of the United States”, published by the Fed.

        It’s the same story in most other economies: The central bank acts as fiscal agent for the Treasury.

        The Treasury could, of course, spend using its own physical tokens – coins – and could tax by collecting back most, but not all, of those coins. Of course, these days, you wouldn’t expect it to use physical coins, but it could use digital coins. One way is for every individual, household and company to have an account, or digital wallet I believe they’re referred to, which would be credited when they were in receipt of a payment from the government and debited when they paid a tax. Of course, in order for these digital coins to be of any use as a means of exchange, there would also need to be a payments system whereby I could pass an instruction to have my account debited and your account credited. Of course, that would mean a lot of separate accounts the Treasury would have to manage, so maybe it could make use of the infrastructure already present in the banking system, whereby only the banks would have digital coin wallets and the Treasury would spend by instructing the banks to credit the current account of the recipient of its spending with the Treasury, in return, crediting the digital wallet of the bank. Taxation would be the reverse – the taxpayer’s current account would be debited and his or her bank would have its digital wallet debited.

        That would work perfectly well.

        The UK Treasury doesn’t do this, though, because it’s got its own central bank to do it on its behalf, acting as its fiscal agent!

        The last scenario I described is just the reserve banking system. It’s how the Treasury makes payments and collects taxes, just that it uses the BofE as an intermediary between itself and the banking system. Reserves are digital banknotes rather than digital coins (is there a difference?) – they get credited to and debited from banks’ reserve accounts whenever the Treasury spends and taxes and banks’ customers have their current accounts credited and debited as they are in receipt of govt payments or making a payment to the govt, respectively.

        Have another malt. Cheers!

  2. Greek and Italian bond yields negative! I’m loosing the plot, throwing in the towel – choose which ever idiom you like. I no longer pretend to understand markets!
    Very little has changed in Greece despite the new government as I regularly talk to Greek friends who tell me it’s just more of the same. And yet markets behave as if the economy is booming.
    I give up!! I’ll stick to reading Shaun’s analysis.

    • You are not the only one who cannot believe that Greece and Italy are in negative territory. It is not so long ago that no-one would buy Greek bonds for fear of not getting all their money back. Now that it is certain, with negative rates, that you won’t get all your money back, they are sure fire investments!

      • markets are and always have been constructs of the state. From Romans , to meso american states, and so on, they have been founded for the peasants to trade for needy goods.

        Todays modern contructs ( which in most cases for the West can be traced back to the Poor Knights of the Temple , so I beleive.) are far more complex but are still not “free” as you would have been lead to beleive if you listened to Mrs Thatcher.
        ( even Adam Smith ) .

        That “free market” was just the loosing of the regulations allowing more ” creative” terms of business and allowing more players to participate.

        I would posit that proof needed is in the difficulty in setting up new market palyers due to regulations set out to prevent all sorts of maladies ( often fraud related and capital intensive too boot ).

        As for the current Greek and Italian situation , they are in the Euro , defacto the Deutsche mark. They are backed by the Germans , so not really too suprising as the Bundes bank , sorry ECB , has repeatedly stated it ” will do what ever it takes ”

        So in an uncertain world they’re not that risky , since Italy is now unlikely to leave , yet alone the Greek .

        Forbin

  3. Hello Shaun ,

    in about 30 days time I predict ( whoa! ) that the fatality rate from the SARS2-CV19 bug will drop to about 2.6- 2.7 % . from the current 3.395%. ( remember when it was 20.8% ? ) .

    Are we seeing in the markets some idea of the impact of this news?

    Come the end of Febuary 2021 it may well be as low as 1.25 % -/+ 0.1 if current trends continue.

    Maybe this is being priced in ?

    ( god knows where we will find 38 billion from , maybe we will not need to ! )

    Forbin

    • I’m sorry, but because of linkage rules I have to spread this over a number of posts.
      The “mortality” rate will remain high until we’re under way in the Great Reset.
      For those dim enough to believe this is a conspiracy theory:

      • Don’t waste your breath or your effort trying to talk to them , you only have to see the response on here to the posts by you and me, to see they believe the covid hysteria pumped out by the BBC and other MSM presstitutes over their own common sense(what little they have) and still believe that in this day and age that their government actually runs the country and makes all the important decisions in the best interest of its people and the country as a whole – the ludicrous nonsensical response to controlling this virus that often contradict other regulations and orders, has been seen by many as proof that there is something else driving this covid agenda. Climate change, the move to electric vehicles and the green policies to enforce the changes our leaders will tell us are necessary to save us together with covid legislation(including forced vaccinations) will be used to destroy our economies, our way of life and our children’s futures. Add in the abolition of cash, central bank digital currencies the acceptance of the current lockdowns and restrictions has only given them the green light to move to the next stage probably even faster than they ever imagined possible.

        When, not if it comes about, they will still think it was going to happen anyway, disregard the predictions and keep tuning into the BBC so that they can tell them what to think next.

      • These are positive discussions and I’m glad that they are taking place. There’s not much I would argue with ( except perhaps the degree and short terms threat of global warming) therefore I do not see a threat. Nor do I believe that Covid is in anyway deliberate to achieve these aims. These are altruistic objectives that Covid has brought into sharp focus.
        I’m only disappointed that population growth never gets a mention at these events as a serious threat to the world. If you analyse pollution growth, shortages of resources, CO2 emissions etc etc it always comes back to population growth.
        The nutters of course insist that we are all going to be sterilised via a Covid vaccine!! Why they ignore all the other vaccines we have had and focus on Covid – I don’t know. Maybe social media wasn’t around when they were developed.

        • I remember everyone saying how good it was when Thatcher talked about “incentives” to work harder.
          Sounds positive, except the rich got the carrot incentives & the poor got the stick ones.
          Remember, these people are deciding everything for us, without giving us any say, or vote, or referendum.
          No-one is saying that a coronavirus vaccine is going to sterilise us, but it is only govts. reactions to coronavirus which mean that, a year later, a vaccine is considered necessary; still, Pfizer don’t mind.
          We already produce twice the amount of food that we need, without moving to plant-based diets or any such fascist nonsense, ever-population is tptb greatest, blackest lie, and only twisted, masochistic misanthropes and dupes believe it.
          The planet can, without stress, handle double the present population, and that is without the input of Bill Gates, Rajendra Pachauri or Monsanto and their frankenfoods.
          The only reason to adopt non-organic farming methods in the first place was to use up the surplus ammonium nitrate of two World Wars.

          • Fortunately modern farming methods is producing sufficient crop yield to feed the world but I don’t believe that food is the major issue of over population. As a fully paid up member of the carnivore club I agree that forcing us onto a plant based diet would be fascism – but I don’t think it will happen. There are large areas of the world that are only suitable for raising animals and not crops so there’s plenty of room and plenty demand.
            Having visited places like Nigeria and seeing first hand the effects of over population ( which is still growing rapidly) I firmly believe that this is the greatest threat we face. It causes massive pollution, competition for resources and conflict.

            As for the Corona vaccination theories – goodness you should have a look at some of the claims made on the crazier blogs on the internet – sterilisation, injection with micro chips, 5G, Bill Gates plans to take over the world ( despite trying to give his money away) etc etc. You couldn’t make it up – but lots of people do!

          • The “problem” with farming animals isn’t land shortage, (that was the 1990s opposition angle) it’s “climate change.”
            Another black lie, climate “science” is in disarray if you’re not a MSM moonie.

          • “For climate change, there are many scientific organizations that study the climate. These alphabet soup of organizations include NASA, NOAA, JMA, WMO, NSIDC, IPCC, UK Met Office, and others. Click on the names for links to their climate-related sites. There are also climate research organizations associated with universities. These are all legitimate scientific sources.
            If you have to dismiss all of these scientific organizations to reach your opinion, then you are by definition denying the science. If you have to believe that all of these organizations, and all of the climate scientists around the world, and all of the hundred thousand published research papers, and physics, are all somehow part of a global, multigenerational conspiracy to defraud the people, then you are, again, a denier by definition. 
            So if you deny all the above scientific organizations there are a lot of un-scientific web sites out there that pretend to be science. Many of these are run by lobbyists (e.g.., Climate Depot, run by a libertarian political lobbyist, CFACT), or supported by lobbyists (e.g., JoannaNova, WUWT, both of whom have received funding and otherwise substantial support by lobbying organizations like the Heartland Institute), or are actually paid by lobbyists to write Op-Eds and other blog posts that intentionally misrepresent the science.”
            https://thedakepage.blogspot.co.uk/2016/12/how-to-assess-climate-change.html

    • Hi therrawbuzzin

      That depends on how ready we are. As far as I can tell issues like green energy makes us less ready. Although I do recall The Sky At Night suggesting there are some plans in place.

      For those wondering about this here is NASA on the subject.

      “At the time, the link between auroral displays and the Sun was not yet known, and it would be the Carrington Event of 1859 that would solidify the connection for scientists not only due to observations performed by Carrington and Hodgson but also because of a magnetic crochet (a sudden disturbance of the ionosphere by abnormally high ionization or plasma — now associated with solar flares and Coronal Mass Ejections) recorded by the Kew Observatory magnetometer in Scotland during the major event.

      On 1 September, Carrington and Hodgson were observing the Sun, investigating and mapping the locations, size, and shapes of the sunspots when, just before noon local time in England, they each independently became the first people to witness and record a solar flare.

      From the sunspot region, a sudden bright flash, described by Carrington as a “white light flare,” erupted from the solar photosphere. Carrington documented the flare’s precise location on the sunspots where it appeared as well as where it disappeared over the course of the 5 minute event. ”

      https://www.nasaspaceflight.com/2020/08/carrington-event-warning/

      • It caused fires everywhere, with telegraphic equipment combusting.
        If it happens anytime soon, the whole planet loses ALL electronics. frazzled by the associated coronal mass ejection.
        Carrington even type solar flares are due approx every century, and the last was 1859.
        The Earth’s magnetic field has been reducing in strength for some time, so a smaller cme would do the same damage.
        It would fry the electiricity grids.
        No lights, heating, no tv, cars, computers, all electronic memories wiped.
        We had a very narrow squeak in Sept 2017, when an x9.3 flare missed us by a small margin.

          • Or perhaps they don’t mind it, because it really would wipe the slate clean.
            No computer hard-drive would survive.
            Another reason why President(non)-elect Schwab wants everything digital.

  4. Shaun,

    With all the talk of a corona vaccine boosting stock markets one would have thought bonds yield would have made more of a positive move than has occurred the last few days with the bearing in mind we only knew over the weekend.

    However the damage has been already been in most major markets and its changed the we work and buy our goods in the UK and we will now have to do things differently, so it will take sometime for all this to work through the financial systems.

    What I did notice earlier was German GDP forecast not as bad as previous forecast but a weaker forecast next year of 3.7% from a previous forecast of 4.9%.

    I think most on here are always sceptical of forecasting ahead with the damage the coronavirus is doing and it would only take the regulators not to approve the vaccine for all forecasts having to be redone.

    On another theme I wonder what will happen to UK house prices now and whether it will continue to give the UK public continued confidence to purchase?

    I get the feeing a propaganda exercise going on in the UK now with the Pfizer vaccine the GOV already telling us they have already ordered 20 million doses and the vaccine will be given to the most vulnerable first and key workers, probably nurses and doctors who are looking after the sick.

    The markets have had a good three days so far but I get the feeling the positive bounce will fizzle out soon.

    But going back to bond yield’s the small moves the last three days suggests to me that the world economies still in a rut and it will take a few more months to get more clarity on the world growth to improve.

    • Hi Peter

      I think bond markets are playing a bit of a game right now. They know that a fast rise in bond yields will see the US Fed return to QE on a much larger scale. Maybe they will give it a couple of days or so and then go for the 1% yield in the US ten-year.

      Then we wait to see at what point the US Federal Reserve responds….

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