Advertisement
Features

Bond yields give mixed messages

The gap between the yield on US ten-year Treasury bonds and the yield on two-year bonds is a mere 0.5 – the narrowest it's been since 2007. What should we make of this?

894_MW_P05_Markets_Main
The Fed will keep raising short-term interest rates

uschools

"Round numbers would be irrelevant if investors were rational," says The Economist. "But they are not." Last week, for the first time in over four years, the yield on the ten-year US Treasury-bond surpassed 3%, reflecting falling prices, "and investors shuddered".

The move was deemed further evidence that the long bond bull market, which began in the early 1980s, is definitively over. As we embark on an era of higher long-term interest rates, corporate and consumer borrowing costs will rise, tempering growth. Given the unprecedented debt load the world economy is carrying, this could lead to a sharp slowdown, especially if rates rise quickly.

Advertisement - Article continues below

The overall pick up in rates "is easy enough to explain", as the Financial Times says. The US Federal Reserve has signalled that it will keep raising short-term interest rates, while a big fiscal stimulus is being added to an already buoyant economy, raising inflation expectations (bad news for bonds as rising prices erode the value of fixed income). But what's rather odd is that the ten-year yield hasn't gone up much compared with the two-year one.

The gap between them is a mere 0.5%; it hasn't been this narrow since 2007. A flat yield curve typically implies low inflation and sluggish growth years into the future. What to make of the mixed messages?

QE has distorted the market

One possibility is the market is expecting short-term rates to rise amid Fed rate hikes but thinks that the Fed will thereby damage longer-term growth in the overly indebted economy, leading to a recession or stagnation.

Advertisement - Article continues below

But perhaps more likely, says John Authers in the Financial Times, is that after years of artificial interference in the bond market in the form of central-bank quantitative easing (QE), which involved buying bonds with printed money, we can't really read anything much at all into the flat curve. Other central banks are still suppressing their yields by buying bonds, prompting pension funds, "desperate to buy at a decent yield", to exploit any uptick in US yields, sending them down again.

For now the key is to keep an eye on inflation. If it surges, it could turn an orderly rise in bond yields into a "rout", damaging growth as companies and households face a steep rise in bills. Worryingly, not only is the labour market gradually tightening, but the US economy is facing capacity constraints that imply higher prices, says Irwin Stelzer in The Sunday Times. The backlog of orders for US manufactured goods is at a 14-year high, and firms are missing skilled drivers to shift goods from warehouses. In Europe, companies are complaining about equipment shortages. We may soon hear a lot more about round numbers in the bond market.

Advertisement
Advertisement

Recommended

Visit/glossary/bonds
Glossary

Bonds

A bond is a type of IOU issued by a government, local authority or company to raise money.
19 May 2020
Visit/519858/how-long-can-the-good-times-roll
Economy

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
Visit/511283/investors-are-going-bonkers-for-bonds
Bonds

Investors are going bonkers for bonds

In a further sign of the mania gripping the bond market, Germany issued €3.15bn of zero-interest ten-year bonds last week.
18 Jul 2019
Visit/investments/bonds/government-bonds/601413/gilt-yields-head-below-zero
Government bonds

Gilt yields head below zero

Yields on gilts – UK government bonds – have gone negative, meaning investors are paying the Treasury to borrow money from them.
28 May 2020

Most Popular

Visit/investments/commodities/industrial-metals/601401/money-printing-infrastructure-base-metals-copper
Industrial metals

Governments’ money-printing mania bodes well for base metals

Money is being printed like there is no tomorrow. Much of it will be used to pay for infrastructure projects – and that will be good for metals, says …
27 May 2020
Visit/economy/eu-economy/601422/heres-why-investors-should-care-about-the-eus-plan-to-tackle-covid-19
EU Economy

Here’s why investors should care about the EU’s plan to tackle Covid-19

The EU's €750bn rescue package makes a break-up of the eurozone much less likely. John Stepek explains why the scheme is such a big deal, and what it …
28 May 2020
Visit/investments/funds/601385/in-support-of-active-fund-management
Funds

In support of active fund management

We’re fans of passive investing here at MoneyWeek. But active fund management has its place too, says Merryn Somerset Webb.
25 May 2020