The US is near to joining the ever growing world of negative interest-rates

by Shaun Richards

Sometimes a piece of news comes with a splash of deja vu or if you prefer groundhog day. I had that sort of feeling last night when I noted via a tweet from John Authers who used to write The Long View at the Financial Times that the US five-year bond yield had fallen to a new low of 0.28 %. My immediate thought was is it going negative too? We have seen this happen in the Euro area with Germany the leader of the pack. More recently we have seen it in my home country the UK where both the two-year and five-year bond or Gilt yields have been negative for several weeks now. That is really rather extraordinary in the UK’s case but we know that these events are accompanied by a litany of official and media denials.

US Federal Reserve

We have become used to bond markets being like the puppet on a string that Sandie Shaw sang about in the 1960s.That was true as the Fed slashed interest-rates to the present just above zero and started on a wave of Treasury Bond purchases that peaked at 125 billion Dollars a day. At that point the Fed took a very tight grip on the string with market players becoming marionettes.

But now the rate of purchases has fallen since the beginning of June to 80 billion Dollars a month.There will be a knock-on effect from the 40 billion Dollars a month of Mortgage-backed Securities but even so the net effect since June began is the same as the daily peak. It is a sign of the times that such numbers now seem so small but compared to the scale of Treasury Bond issuance they are.

During the July – September 2020 quarter, Treasury expects to borrow $677 billion in privately-held net marketable debt, assuming an end-of-September cash balance of $800 billion.

With the way that the Covid -19 pandemic seems to be spreading again in somes US states that looks likely to be exceeded. So Mr and indeed Ms Market are buying US Treasuries.

Yield Curve Control

This idea has come to prominence as the US Federal Reserve has looked across the Pacific to Japan. There the Bank of Japan has targeted the benchmark ten-year yield aiming to keep it initially around -0.1% and now between it and 0%. Frankly I do not think it could be clearer cut that this is really about allowing the government to borrow cheaply and in some cases at no cost at all. It is not for the economic impact as pre pandemic the Japanese economy was shrinking. Putting it another way you do not change the name of a success and yet in Japan we have had QE,QQE and now Yield Curve Control.

A side – effect of this is that the bond market effectively dies in terms of volume so once you start it you end up si ging along with Elvis.

We’re caught in a trap
I can’t walk out
Because I love you too much, baby

So we seem to be in a situation where some market players are simply front – running what they expect the Fed to do.

Stock Markets

It used to be the case that bond markets rallies like this required equity market falls, if not plunges. Whereas now Yahoo reports this.

The broader market, however, ended Thursday’s session lower. While the Nasdaq Composite powered to yet another record high, S&P 500 ended lower, and the Dow fell by 361 points, or 1.4%, for its lowest close in six days. Each of Apple, Amazon, Netflix and Microsoft hit record closing levels again on Thursday, with investors crowding further into tech and software names viewed as most likely to recover strongly in the wake of the pandemic.

As you can see the FAANGs continue to surge and are taking the NASDAQ with them. Some of this is being oiledby the centrl banks with the Bank of England joining the US Federal Reserve in buying Apple bonds. Overnight  we have seen ralies in China too so we see in the modern liquidity driven era that asset markets run in a pack. So much for both hedging and risk management.

Inflation

Officially the story is that there  isn’t any but I notice that fewer and fewer people buy that these days. The US CPI is essentially unchanged on a year ago but there is a catch.

Declines in the indexes for motor vehicle insurance, energy, and apparel more than
offset increases in food and shelter indexes to result in the monthly decrease in
the seasonally adjusted all items index. The gasoline index declined 3.5 percent
in May, leading to a 1.8-percent decline in the energy index. The food index, in
contrast, increased 0.7 percent in May as the index for food at home rose 1.0
percent.

The essential items people have been buying have risen in price whilst the things they haven’t have been falling. What could go wrong?

However you spin it there is very little allowance for inflation in a 0.28% five-year yield and the real yield will be negative.

Comment

I have left out the economic outlook until now so let me bring it into play.

ew York Fed Staff Nowcast
The New York Fed Staff Nowcast stands at -15.1% for 2020:Q2 and 10.4% for 2020:Q3.
News from this week’s data releases increased the nowcast for 2020:Q2 by 1.2 percentage points and increased the nowcast for 2020:Q3 by 8.9 percentage points.

This week’s pandemic news means they seem set to subtract some of the expected growth for Q3. Thus not only has the outlook turned down it remains extremely volatile. Ordinarily I would say that would make bonds more attractive but of course that relied on them having a yield which these days is fast disappearing.

Another source of demand comes from the US Dollar because the safest place to hold Dollars is in Treasury Bonds. The more uncertain things look the more Aloe Black will be singing ” I need a $ a $ is what I need”

On these roads we see that US Treasury Bond yields are slip-sliding away and the two-year at 0.15% is in the van. In my country  the UK when the final push came it happened quite quickly.