What are lower bond yields telling us?

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by Shaun Richards

A major story in 2021 so far has been the moves in bond yields. This matters because they have become more significant in economic terms during the credit crunch. A factor in this is the way that the ZIRP era of effectively 0% official interest-rates has pretty much stopped the game there for now. For example the US Federal Reserve is presently trying to stop more US rates going below zero. Even the European Central Bank which has applied negative interest-rates for some years now thinks it is at its limit as we learn from the denial below.

SCHNABEL#ECB ISN’T AT EFFECTIVE LOWER BOUND BUT IS CLOSER ( @LiveSquawk)

Putting it another way their last move was a paltry 0.1% cut to -0.5% although of course they sneaked in a -1% for the banks.

If we step back and ask why?The answer comes from the early days of the credit crunch when official interest-rates were slashed but economies did not respond as the central bankers hoped they would. In effect they thought they had more economic power than they did as longer-term interest-rates cocked something of a snook at them. So we got QE bond purchases in an attempt to control them as well, but whilst this has been associated with lower bond yields the link has been far from what you might think.

Last Night

Whilst many of us in the UK had our eyes on Wembley last night the Federal Reserve released the minutes of its most recent meeting.

On net, U.S. financial conditions eased further, led by a decline in Treasury yields.

Remember this was from mid-June and in terms of central banker psychobabble you can explain it like this.

Lower term premiums appeared
to be a significant component of the declines, as reflected by lower implied volatility on longer-term interest rates.

There had also been bad news for those using real yields as a measure.

The median 2021 core personal consumption expenditures (PCE) inflation forecast from the Open Market Desk’s Survey of Primary Dealers jumped nearly 1 percentage point from the previous survey. However, median forecasts for 2022 and 2023 each rose less than 0.1 percent, suggesting expectations for inflationary pressures to subside.

The Federal Reserve is of course desperate to emphasis anything agreeing with its claim that inflation will be transitory. But the problem for those seeing things in real yield terms is that the higher inflation forecasts should lead to higher bond yields and we got lower ones. Oh Well! As Fleetwood Mac would say.

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Oh and I did point out earlier that the Federal Reserve is trying to stop short-term rates going below zero.

Amid heightened demand and reduced supply for short term investments, the ON RRP continued to maintain a
floor on overnight rates.

Taper 

Here things get a little awkward again. Because any reduction in the current rate of purchases ( $80 billion of US Treasury Bonds and $40 billion of Mortgage-Backed Securities a month) should lead to higher bond yields. Except for all the talk it still seems some way away.

In coming meetings, participants agreed to continue assessing the economy’s progress toward the Committee’s goals and to begin to discuss their plans for adjusting the path and composition of asset purchases. In addition, participants reiterated their intention to provide notice well in advance of an announcement to reduce the pace of purchases.

This backs up this from the statement at the time.

The Committee expects
to maintain an accommodative stance of monetary policy until these outcomes are achieved

Timber!

An exaggeration but there is a point behind it. Highlighted in a way by this from Reuters.

“If we do see a further drop in interest rates, if we do get below that 1.3% level in any kind of meaningful way, that is going to confirm that growth over value has returned and it is not just a head fake,” said Matt Maley, chief market strategist at Miller Tabak.

Actually the US ten-year yield is 1.26% as I type this as we wonder if that is meaningful enough for Mr. Maley? This compares to 1.78% earlier this year as the yield party peaked and 1.6% just after the Federal Reserve meeting and its hints of a couple of interest-rate rises in 2023. So if you have been long bonds well played.

Back to the economic implications and we start with the US government being able to borrow very cheaply again. Related to that is that long bond (30 year ) yield and its impact on mortgage rates.

Mortgage rates have fallen fairly consistently over the past 2.5 weeks with the past 2 days seeing some of the better improvements…….

They have the 30-year at 3.07% with Freddie Mac going below 3% to 2.98%. I doubt today’s fall to 1.88% for the long bond is factored in but of course the day is not over and things might change.

The International Effect

We can see one via Yuan Talks.

#China‘s most-traded 10-year #treasury futures extend gains to more than 0.5% to hit the highest since Aug, 2020. The yield on China’s 10-year govt bonds drops by 6.25 bp and break through 3% mark to hit 2.9925%.

If we switch to Europe one of my subjects this week – France- has seen its ten-year yield move to a whisker away from 0% this morning. Germany has a thirty-year of a mere 0.15%.

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If we travel to a land down under he get a new sort of insight into QE. This is because the Reserve Bank announced a reduction in the rate of it by around 20% from September. The knee-jerk response saw the ten-year yield rise to 1.48% but only a couple of days later it is 1.3%.

The Global Dunces Cap goes to the Bank of Japan. You may recall that a few months ago Yield Curve Control was all the rage. Maybe even fashionable if an economic concept can be. But by pinning the ten-year yield the Bank of Japan stops it from falling and effectively undertake a sort of reverse Abenomics. So it has only moved within the permitted range from 0.06% to 0.02%. I guess that counts as a big move for JGBs these days.

I suspect that has contributed to today’s rally in the Japanese Yen as it moved through 110 although currencies rarely move for one thing alone.

Comment

The pendulum keeps swinging in 2021. Markets tend to overshoot but even that theory is awkward now as we note how large the narrative is versus how small the bond yield moves have been. I have worked through plenty of occasions where a 0.5% move would not be considered much and one comes to mind ( White Wednesday 1992) when it was happening if not in seconds in minutes.

Is this a cunning triumph by the US Federal Reserve as some argue? I do not think so as that is way over emphasising their ability. Putting it another way if so they have just poured petrol on the house price rise fire via the impact on mortgage rates.

Switching to the UK we see the same themes in play. The fifty-year yield is back below 1% so the government can borrow incredibly cheaply just as theory tells us it should be getting a lot more expensive. Also we may see more of this.

Record low rate on a 60% LTV 2yr fix of 1.15% in June. No wonder that mortgage mover numbers and house prices are up. Average quoted rates are falling on higher LTVs but still higher than pre-pandemic. ( @resi_analyst )

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