Why are bond yields falling again?

by Shaun Richards

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.


As you can see this is a new yield low and as well as this we have seen some old friends return. From Monday.


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.


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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?


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.


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