Where next for interest-rates and bond yields?

2021 has opened by reminding us that the world has become increasingly bi-polar.Perhaps I should refine that to the human world. Prospects for interest-rates are doing that as well and let me give you an example of one trend.

Government bond #yield keeping higher: 10 year German #Bund yield at -0.48%, 10 year UK Treasury #Gilt yield at 0.32% and 10 year US #Treasury yield at 1.15%. (@CIMBank_News)

The player here is the United States. I noted yesterday the impact of higher US bond yields on the price of Gold and in the meantime the ten-year has nudged higher to 1.15%. Part of this has been caused by the way that the prospects for Yield Curve Control ( essentially more QE bond buying) have collided with this.

WASHINGTON (Reuters) – The Federal Reserve could begin to trim its monthly asset purchases this year if distribution of coronavirus vaccines boosts the economy as expected, Atlanta Fed President Raphael Bostic said on Monday in what amounted to a bullish outlook for the coming months.

As you can see they have been talking bond yields higher just as they were expected to be heading in the opposite direction. So much for Forward Guidance! This is more like a car crash as we wait for the handbrake turn. Just to add to the land of confusion there was also this.

In separate comments, Chicago Fed President Charles Evans also said policymakers were poised to push bond-buying in either direction – adding more if the economy seems to need it but also open to cutting back if the recovery and vaccines gain traction. ( Reuters)

On a technical level this just reminds us how useless Forward Guidance is. We have seen central bankers and their acolytes push it as a policy tool but right now they are pulling in every direction. How can anyone take guidance from this.

Mr and Mrs Market have decided to push bond yields higher and see if they break.Those who remember what was called the Taoer Tantrum and the climb down of the US Federal Reserve in the face of pressure from President Trump will no doubt be thinking when they climb down. Such thoughts are no doubt behind the rise in bond yields because so far QE has been an example of the genius of the song Hotel California.

“Relax”, said the night man
“We are programmed to receive
You can check out any time you like
But you can never leave”

Negative Interest-Rates

On the other side of the coin is the negative interest-rate enthusiast of the Bank of England Silvana Tenreyro. Yesterday she gave a speech setting out her views on them.

Financial-market channels appear to be unimpeded under negative rates, and some may even be
stronger than usual.
 While pass-through to household deposit rates can be constrained near zero, pass-through appears
to be less constrained for corporate deposit rates, which may stimulate spending by firms.
 There is strong evidence of transmission into looser bank lending conditions, even if this is
somewhat constrained relative to ‘normal’.
 There is no clear evidence that negative rates have reduced bank profits overall, and a number of
studies find positive impacts, once you take into account the boost to the economy.
 Taking these points together, the evidence suggests that negative rates can provide significant
stimulus.

Let us examine these in detail. Her view on the financial market channel is really rather extraordinary, so let us take a look in more detail. The emphasis is mine.

For example, estimates from the Bank’s suite of models suggest that financial market channels – operating via the exchange rate, firms’ cost of capital and households’
financial wealth – account for a third to two thirds of the total medium-term impact on output from Bank Rate
changes, and a half to three quarters of the impact on inflation.

Yes we are back to wealth effects again with no addressing of the issuing for younger people of how they will have to buy more expensive assets is inflation for them.We look at this usually in terms of housing. Also if firms cost of capital responded to Bank Rate in the manner hinted at we would not have had the Funding for Lending and Term Funding Schemes. 

Next is the issue of corporate deposit rates which “may” stimulate corporate spending. Well after the years of evidence now about the impact of negative interest-rates in the Euro area then if you can only say “may” it means the answer is no. Although Silvana keeps plugging away at this.

This suggests one aspect of the banking channel of negative rates which could be more powerful than usual.

How bank lending can be both “looser” and “somewhat constrained” speaks for itself so I will leave that there.

Next comes the issue of the banks. The issue her is one of profitability or rather lack of. Her Silvana finds herself trapped between her theories and real world examples where people are backing their views with their money.

Interestingly, a number of studies48 – though not all49 – find that bank equities tend to fall after policy rate
cuts below zero are announced. That seems at odds with the more sanguine results on bank profitability.

Revealingly she decides that she is right and they are wrong.

One interpretation is that financial markets initially focussed on net interest income, but did not initially
account for the indirect boost to profits from negative rates arising from improvements in other sources of
income.

Indeed they have been wrong for quite some time according to her. It would be too cruel to look at the Italian banking sector so let us go to the benchmark for the Euro area banking sector which is Deutsche Bank. Back in 2015 there were two occasions when its share price approached 29 Euros whereas now it is 9.57 Euros. If we take out the Covid-19 pandemic then we see it does not change much as in February last year it was 10.2 Euros. So the share price has plunged over the era of negative interest-rates and bond yields because markets have failed for over five years to spot the “improvements in other sources of income.” Come to think of it the accountants and auditors have missed it as well!

We seem to be entering something of an alternative universe here.

And I have previously highlighted that in the UK interest rates affect inflation more quickly than in the past.

The ECB in fact published some work a few years back suggesting the reverse. I can only think that Silvana has misunderstood what happened in the summer of 2016.

Also we already have negative UK bond yields in the UK at the shorter maturities mostly due to all the QE bond buying she does not think is that important.Meanwhile that influences the increasing number of fixed-rate mortgages. On that road Bank Rate is ever less important which she seems to miss.

Comment

There are several contexts here so let me set out my view. There is a clear asymmetry between how central bankers regard interest-rate rises and cuts. The former are a vague wish and the latter are a clear desire often implemented via panic. Indeed interest-rate rises are often reversed ( the UK is an example of this ) and the new scenario is lower. For example the Bank of England told us the “lower bound” for UK interest-rates was 0.5% whereas Bank Rate is presently 0.1%. In a sane world we would be projecting interest-rate increases but in the insane one we inhabit any further economic weakness will see more cuts.

Next comes the issue of negative interest-rates which so far have been singing along with Muse.

Super massive black hole
Super massive black hole
Super massive black hole
(Super massive black hole)

The main place that has implemented them which is the Euro area is still there. In fact last year it cut again, although contrary to the Tenreyro rhetoric it only cut by 0.1% showing it sees risks. If negative rates had the impact claimed surely things would have got better and interest-rates could have been raised or at least returned to zero? The Riksbank in Sweden has raised back to 0% but that only illustrates the issue. It cut into negative territory in a boom and ended up so unsure about it all that it raised interest-rates in a bust. If they worked surely Sweden would have them now?

 

14 thoughts on “Where next for interest-rates and bond yields?

  1. hello Shaun,

    need to keep an eye on the Fed, not at all sure they’ll cut feeling is that they’ll stick or go for a token rise…..

    BoE will be watching closely

    Forbin

    • Hi Forbin

      The main issue in the short-term is what the US Fed does with QE and bond yields. I do not expect President Biden to be a vociferous about bond yields and interest-rates as the Donald. But with his spending plans. US bond yield rises will soon get very expensive.

  2. Broadbent backed off this morning on negative interest rates however that still leaves the gate open to cut to zero!

    Just saying!

    As for profitability with rates being lower on the mortgage front a bank can increase its profits with various fees to make up for ,loss of margin.

    What is clear is Bailey also said the economy will take longer to recover from second lockdown and as such there is leeway to cut to zero to assist the economy imo.

  3. As you allude Shaun,negative rates put a downward pressure on on bank margins and profitability.
    I read this iluminating paper by Prfo Kevin Dowd and Dean Buckner last year arguing that the UK banks are in a worse space than 2006.If that is the case,then what damage will be done if the BoE go down that road?

    Dread to think.Things are bad enough already as we await the end of furlough.

    Although,obviously,house prices are reportedly heading higher so everything should be ok (as long as you don’t look behind the headline to the hosuing mix selling-very few terraces and flats outside Londinium).

    Click to access Can%20UK%20banks%20pass%20the%20COVID-19%20stress%20test%206%20May%202020.pdf

    • Hi Dutch

      Welcome back and cheers for the link. I like the idea of looking at market capitalisation for the banks and as they argue it tells a different story from the “resilience” described by the Bank of England. The recent rally in bank share prices will make things look better but has far from cured the issue. There was a time Barclays at circa £1.50 would have been seen as a crisis.

  4. The words of King Crimson seem appropriate here:

    I talk to the wind.
    The wind does not hear.
    The wind cannot hear.

    Pension funds and insurance companies cannot function with negative yields. If any bank starts charging people to hold their cash then people will start taking the money out.

    We know house prices are going up, but what about luxury watches and motor-homes? Basically anything the Greeks bought when they though they were about to quit the euro.

    • I’d posit they are struggling with current rates

      look at their charges , I think pretty soon the penny will drop . Why pay into a 30-40-50 years and get -3% today because the HMG co-opted you in ?

      add on inflation

      might as well get a loan and buy a house or two – well that seems the be the general plan of the UK making things , ie making house prices higher.

      I really don’t think they have any other plan – what could go wrong ?

      getting out just before the “pop” will prove interesting

      Forbin

      • The thing is, if you own property, then no matter the bubble, or the deflation when it bursts, or employment levels, people are still going to need somewhere to live.

        • Ah so we need the words of Ice-T:

          William Morris is my agency,
          I’ll never go broke I got property.

          Or Oldham Athletic Fans:
          To the tune of Yellow Submarine

          We all live in a Robbie Fowler House
          A Robbie Fowler House
          A Robbie Fowler House

  5. We should all be grateful that we finally escaped the “temporary” base rate of 0.5% over the last 10 years or so

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.