The year so far had brought more than a few surprises and some that should not have been. But bond markets have spent much of it singing along with Genesis.
Can’t you see this is the land of confusion?
We began the year with rising yields which followed the path of rising economic expectations for both growth and inflation. So now its Supertramp.
But then they send me away to teach me how to be sensible
Logical, oh responsible, practical
And they showed me a world where I could be so dependable
Oh clinical, oh intellectual, cynical
On that road if we use the US ten-year yield as a world benchmark we saw it rise above 1% early in January and go as high as 1.78% in March. If we stay with the logic theme it did not rise by remotely enough to cover either expected growth or inflation but it did head in the right direction. The problem we have is that the numbers it is compared to are never from the same time frame but this poses quite a question for the latest complete quarter.
Current‑dollar GDP increased 13.0 percent at an annual rate, or $684.4 billion, in the second quarter to a level of $22.72 trillion. ( US BEA)
That is nearly 2 years of purchasing power gone in one quarter.
However it did not last as the yield rally struggled and then turned south as we move onto Paul Simon.
Slip sliding away
Slip sliding away
You know the nearer your destination
The more you’re slip sliding away.
Where are we now?
The US ten-year is a mere 1.18% which covers neither growth nor inflation and we see the influence of this rippling around the world. From this morning.
*ITALY 2-YEAR YIELD BELOW ECB DEPO RATE OF -0.5% FOR FIRST TIME ( @lemasabachthani )
As you can see this is a new yield low and as well as this we have seen some old friends return. From Monday.
ENTIRE GERMAN BOND YIELD CURVE NOW IN NEGATIVE TERRITORY AFTER GERMANY‘S 30-YEAR YIELD TURNS NEGATIVE FOR FIRST TIME SINCE EARLY-FEB ( @DeltaOne)
If we take the economic numbers we have seen the German economy is growing with this earlier from the Markit PMI.
The Germany Composite Output Index hit a new record high of 62.4 in July, up from 60.1 in June and surpassing the previous record set in June 2006. Strong increases in activity were seen across both the manufacturing and service sectors.
Also it was only last week the Bundesbank reported that inflation might go above 5% later this year. So however you spin our logical song arguments they have had a disaster. This is true across the Euro area in general as Reuters have reported.
Tradeweb said on Monday more than 70% of euro zone government bonds on its platform carried negative yields, while more than half investment-grade corporate bond yields were sub-zero.
Number Crunching
Let me now shift to what is happening and a factor is one I have described before which is that we have shifted from yield to capital gains. As it happens we have seen it in housing too. But if we start from a 1.18% yield in the US it makes little sense using traditional metrics. But now think of my capital gains theory as you read this.
Should US Treasury yields decline from today’s values to lows realized in Germany (1.3% to -0.8% for the 10-year and 1.9% to -0.5% for the 30-year), the associated price appreciation would be roughly 24% for the 10-year note and 75% for the 30-year bond. More conservatively, should yields decline to zero, the associated price appreciation would be roughly 15% for the 10-year note and 55% for the 30-year bond. ( aqr.com)
So from the point of view of your typical bond punter, excuse me investor, that is the new game. They are in fact trading for a hoped for capital gain and the yield is for this purpose almost irrelevant. From the point of view of the US it is an extra gain but not much and that is true to a lesser extent of the UK. In the Euro area yield is a loss and you hope to move the bond on like it is a hot potato although someone has to eventually hold it.
QE
Regular readers may have spotted that there is much that is familiar here with my past explanation of QE where investors buy to be bale to sell to the central bank. This can come in two forms of which the first is for a profit and the second is using it as a type of stop-loss or if you prefer put option.
In the present situation of positive growth and worries about inflation you might reasonably think that QE would be over. But the Bank of England will but another £1.15 billion of UK bonds today and the US Federal Reserve continues with its US $120 billion a month of bonds purchases. Then there was this from the ECB in its last policy statement.
we continue to expect purchases under the pandemic emergency purchase programme (PEPP) over the current quarter to be conducted at a significantly higher pace than during the first months of the year.
That is no great surprise for us as I have always expected the full PEPP to be used but some believed the ECB statements that it might not. Even we got a confirmation of a higher rate of purchases continuing as others found they had been wrong-footed.
The Theory
Here is the view of Gertjan Vlieghe of the Bank of England.
the main and persistent effect of QE has come through
lower expected real rates, keeping inflation expectations anchored and lowering expected nominal yields by
revealing our reaction function at the ELB.
Actually the Effective Lower Bound has kept getting lower which to be fair he does mention but does not fully address. For example in the UK the Bank of England claimed it was 0.5% before cutting to 0.1% and how Gertjan has spoken about -0.5% and -0.75%. That may be solved by a stroke of a pen in theoretical models but in the real world it matters and sometimes a lot.
He also adds this.
Beyond expectations, I believe QE has a liquidity channel
(through the level of reserves in the banking system) and a temporary term premium effect, but this
temporary term premium effect is much larger during periods of market turmoil than when financial markets
are functioning smoothly.
I think there are a few holes in that not unlike a piece of Swiss cheese. But for our purposes today we are back to the same problem. If you intervene can you ever stop?
Comment
There are all sorts of issues and dangers here and let me start with a warning to Gertjan and his ilk.
There were no trades in Japan’s 10-year benchmark today… despite a 10-year bond auction earlier. This hasn’t happened in early June. BOJ owns ~50% of the JGB market. Let’s hope this doesn’t happen anywhere else. ( @StephenSpratt)
All the talk of expectations and the like disappear because you have a controlled market or if you prefer a real world example of the phrase “never get high on your own supply”. We can see from Stephen an example of this from the Bank of Japan earlier.
Japan 10-year yield hits 0%! At this point, we’re just happy it’s actually trading.
You see it should be much lower. With all the buying and the effectively 0% inflation rate ( this week’s reading for Tokyo was -0.1%) then Japanese yields should be lower and therefore we conclude that in spite of this correction in March they are keeping yields up.
that the range of 10-year JGB yield fluctuations would be between around plus and minus 0.25 percent.
So it can go below 0%? Well later they do not seem quite so keen.
An excessive decline in super-long-term JGB yields could have a negative impact on economic activity from a long-term perspective.
Nice of them to confirm one of my critiques of their strategy.
Notayesmanseconomics's Blog 
Damn, now I’ve got slip sliding away as an earworm! I’ve been saying for years there is no bond market just fiscal and monetary actions by the government that supports a high falutin casino in the City. The age of the bond vigillante is dead. I am an inflation dove which has made me a little profit from my modest day trading. I believe everything has to be this way because if it wasn’t there’d be carnage.
Hi Bill
As each year goes by your are more right as bond markets get ever more controlled. The extreme case is I guess Greece as so little of its debt it in Greek bonds now.
As doe earworms I replied to an online quiz and via a friends reply now have Show me the way by Peter Frampton as mine.
Hello Shaun,
re”If you intervene can you ever stop?”
Do they intend to when they believe its working?
Whats the alternative ? crash and burn ?
you dont stay in power that way
Forbin
Hi Forbin
Yep. It is another form of kicking that poor battered can.
Germany has been a good little Fatherland, accepting inflation for the good of the elite’s agenda, whilst USA, being back in the hands of the globalist dictatorship sees itself being similarly rewarded.
Italy’s globalist technocrat dictatorship? How much has the elite to fear from that?
Don’t kid ourselves that we’re any better; BoJo is just as globalist as any of them. He may have taken us out of the EU, but his agenda is the EU’s agenda which is UN Agenda 2030, & every time I hear him say, “Build back better.” I see the face of Klaus Schwab.
If we’re good, the “market” will buy our bonds, if not, we get “Greeced.”
Govts. may distort the matket, but they are not the whole market.
I notice that, “The Fourth (Reich) Industrial Revolution” has been hastily re-named “The GREEN Industrial Revolution”.
Is anyone really that stupid as to fall for it, other than the bed-wetting, hand-wringing, masochistic, misanthropic, middle class tree-huggers, whom I already despise with a vengeance?
Bring back garotting.
And at the same time lobbyists are clamouring for a tax on meat for ‘environmental reasons’, whilst china et al are planning 600 coal fired power stations:
https://www.theguardian.com/environment/2021/jun/30/five-asian-countries-80-percent-new-coal-power-investment
indeed , I have posted elsewhere on the double standards the UK has to endure …. well the people do .
seems to be little traction in getting people to understand that what we do has little if no impact if China. India and Africa are not doing the same.
but hey ho , we can always out compete them on house price rises …….. sheeesh
Forbin
See Farm-to-Fork.
Also animal rights extremists are pushing for legislation in US states which would make meat production non-viable.
My simple pennies worth as to why bond yields are falling….
1-Well we have world wide debt reaching unbeleivable levels and although growth seems to be picking up, its temorary imo and mainly due to opening up of restrictions and also with fiscal interventions.
2-No one seems to be really concerned over how the borrowings are going to be reduced.
3-At some stage the pack of cards are going to topple over or some take a default.
In conclusion the world is in a bit of a mess at the moment and as such the bond markets are nervous of an asset collapse in one way or another.
In the meantime Taylor Wimpey doesnt accept there is a boom in house prices, well they would say that wouldnt they but in part they concur with what I have beeb saying for some time and that is in with interest rates at all time lows this is part of the reason why house prices have risen to the levels they have, never in my life time have I seen such low levels for such a long period of time. Long term mortage rastes used to be circa 5% and we are now seeing a few year fixes at less than 1%.
1) world wide debt levels are at record levels because worldwide demand for financial assets, or savings, is at record levels
2) borrowings get reduced by either being converted to equity (not clear what this achieves) or by savings being reduced. If worldwide savings reduce, debts automatically reduce.
3) whilst private sector debtors can default, liabilities of the currency issuer (eg liabilities of the UK govt denominated in it’s own currency, the British Pound) cannot. The liabilities of the UK govt have to remain outstanding for as long as demand for net £ financial assets remains. Similar story for the US govt and others.
Arguably the GFC was caused in no small part by a run up of unsustainable and un-serviceabe private debt in the US. This was caused by the Clinton administration withdrawing $ financial assets from the economy by running a surplus at a time when worldwide demand for $ denominated financial assets was increasing.
If we believe that private sector entities should have more savings and less debt (and many do believe that), we have to a accept that is only possible if the public sectors worldwide have larger debts. Public sectors also get to choose what interest rate (if any) to pay on their liabilities. It is always a policy choice.
Hi Shaun
Great article as always. So in the uk we have
council tax +5%
petrol at eight year high
gas bills to rise by £150
housing up 10%
And yet when the media look at poverty they always look at incomes. They never question the fact that everything is becoming a lot more expensive. Low income people are be hammered by non descretionary inflation, but I’m sure the boe will look through it 😉
anteos,
Cost of DIY materials are going through the roof so to speak particularly wood which has more than doubled the last 2 years and still in short supply
https://www.bbc.co.uk/news/science-environment-57920510
UK inflation is likely to creep to closer 4% in the next few months but I think the BOE will ignore it and is hoping it will be short lived.
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when the entire non-govt sector wishes to hold more financial assets than the liabilities and obligations that the non-govt sector is prepared to assume, the extra financial assets can only come from the government (its liabilities, the holder’s financial asset).
Those assets (liabilities of the govt sector) can only be currency or bonds. If the choice is between holding currency at 0% or close to 0%, (and you don’t expect that return to increases by much over a time horizon under consideration), or bonds that return anything above the expected return on the currency, then you will buy bonds, no matter what you expect inflation to do.
And bear in mind that it is the government sector, usually acting through its central bank, that gets to decide what the return on currency (and by extension, the return on govt bonds) is going to be.
And who cares if govt bonds don’t trade on a particular day? So what? Should the government arrange its affairs for the benefit of govt bond traders (like me)?
Hi Robert
There have been occasions in the past when countries have been unable to sell their bonds and this has precipitated a crisis. Usually that is associated with a lower currency as well.
One thing we can agree about is that it is going to be quite some time before interest-rates go up and even then not by much.
currency issuing governments, such as the UK’s, don’t ever need to sell bonds.
It’s necessary if there is a self imposed limit on currency in circulation, such as under a gold standard. It’s also necessary for monetary policy purposes if interest is not paid on excess reserves and there is a non-zero interest rate target.
But with no self imposed limit on the quantity of currency that can be in circulation and no need to defend an interest rate target – a) because interest is paid on all reserves at the target level and b) the target level is more or less zero anyway – there is no requirement to ever sell a bond.