Are trade wars rattling markets, or is it fear of another blow-up in Europe?

As the trade war intensifies, developed-world government bonds have sunk to new lows. But the root cause of the markets' jitters could lie not so much in trade as in fears of another crisis in the eurozone.

Germany's Chancellor Angela Merkel © KENZO TRIBOUILLARD/AFP/Getty Images

Fancy some stimulating debate about the big issues of the day? Where better to join one than in Adam Smith's living room?

Join Dominic Frisby (until 16 August) and Merryn Somerset Webb (from 17 August) and guests for their Edinburgh festival show, The Butcher, The Brewer, The Baker and the Commentator book your ticket here now!

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

I'm on for the 22nd and the 23rd be nice to see you there if you can make it!

Back to today and, my word, yesterday was quite the day for markets.

Advertisement - Article continues below

Bond yields plumbed new depths. Gold soared. Equities swung about a bit before managing to close higher, because equity investors generally like to view the glass as half full, right up to the point at which it gets smashed over their heads.

What's going on?

Bond yields are sinking to new lows

In summer 2016, in the wake of Britain's vote to leave the European Union, bond yields around the world hit their lowest levels on record.

That is, until now.

The vast majority of developed world government bonds have now dropped below their 2016 nadirs (including the UK ten-year gilt).

The US is an exception, though only so far. Below, we see the yield on the ten-year US Treasury from mid-2015 until yesterday. As you can see, it's not far off its 2016 low.

US 10-year Treasury bonds

(Source: Stockcharts.com)

Advertisement - Article continues below

I'll freely admit (as I already have) that I thought 2016 would be the low for yields (and therefore the peak for bond prices). I thought wrong.

So what on earth is going on?

There are murmurings of a "new normal". I notice that Joachim Fels of Pimco has put out a note arguing that negative bond yields (whereby lenders pay money to be allowed to park their money with a given borrower) are being driven by long-term factors. He's warning that US bond yields could eventually turn negative if the Federal Reserve, America's central bank, is forced to restart quantitative easing.

Fels is a smart man and I'd like to take a closer look at the case for negative bond yields in a future Money Morning once I've had time to digest the idea.

However, it is clear that there is at least an element of momentum trading to this move. In other words, it's not all about the fundamentals. Take the 100-year Austrian government bond. By no stretch of the imagination is this a safe haven asset. But it has been an absolutely fantastic performer.

Why? Because the longer the maturity date on the bond, the more sensitive it is to interest rate movements. And as rates have been going down, the Austrian bond has soared. (The opposite would happen if rates go up).

Advertisement - Article continues below

As John Authers points out in his Bloomberg column, Mexican century bonds have also done very well. This again doesn't make that much sense given that "few countries are more exposed to shifts in the global trade cycle".

So I'm not quite ready to throw in the towel on the "bonds look bubbly" argument just yet. While some of the demand for negative-yielding government bonds might be down to a rush for safety based on a negative view of the fundamentals, the surge in the prices of the edgier stuff just smacks of trend-chasing.

Fear of deflation may be driven by fear for the eurozone economy

I do wonder what has spooked the market, though. And casting back to the last full-on deflationary scare in 2016, I'm wondering if they have more in common than perhaps I first thought.

I've viewed the fact that bond yields hit a major low following the Brexit vote as being little more than coincidence. I'm starting to think that's wrong.

The focus in the last week or so has been on the US and the Federal Reserve and China and trade wars. But maybe what's really spooked the markets is Europe.

Germany has released a string of woeful economic data in recent months. Yesterday, we learned that industrial production slid hard in June. It's now looking quite likely that the economy will have shrunk during the second quarter. If Germany goes into recession, that's got to be ugly for Europe.

Advertisement - Article continues below

Meanwhile, of course, Britain looks increasingly likely to end up leaving on a "no-deal" basis. Regardless of how bad you think this will actually be (I tend towards the less melodramatic side), it's not a prospect that's going to make any investor outside of the UK and the eurozone feel comfortable.

In terms of events that could unleash another deflationary collapse on the world, then another proper crisis in the eurozone is perhaps the top candidate. The banking system is still ropey, and not being helped at all by negative interest rates.

Mario Draghi at the European Central Bank (ECB) has done a good job of holding the monetary system together with elastoplasts, but the political side of things is still not a lot further forward than where it was at the end of the last crisis.

Financial analyst and historian Russell Napier has argued that the collapse of the euro would be exactly the sort of unprecedented event that could be being signalled by today's unprecedentedly low interest rates (you can see Russell in person at the MoneyWeek Wealth Summit on 22 November get your ticket here now).

Now, to be very clear, I'm not arguing that we're looking at an imminent collapse in the eurozone, because my gut feeling (for now) remains that when push comes to shove, the political appetite to maintain the whole thing is still too strong.

But a fresh crisis triggered by an economic slowdown and the ECB's limited ability to boost actual growth, rather than prop up asset prices? That could certainly happen, and it could well be a scary moment for markets.

Advertisement - Article continues below

Equally, it might be fended off maybe with another big "bazooka" from the ECB and investors might decide that they over-reacted, and bond yields could edge higher again, just as they did after they hit rock bottom in 2016.

I hate to say it, but we just can't predict the future. The key, as I've said a few times this week, is not to panic. Stick to your plan, and if you don't have a plan, then focus on making one, and don't touch your investments until you've done so.




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

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

It makes sense to lend to governments

No matter how ramshackle or indebted the country, buying its bonds is rarely a bad idea, says Matthew Lynn.
14 Apr 2019
UK Economy

Coronavirus: Big Brother widens his embrace

The coronavirus crisis has led to a massive expansion of the state into all areas of daily life. Should we be worried?
4 Apr 2020

Most Popular


Three things matter for the UK housing market now – and “location” isn’t one of them

The UK housing market is frozen. And when it does eventually thaw out, the traditional factors that drive prices will no longer apply. The day of reck…
1 Apr 2020

What does the coronavirus crisis mean for UK house prices?

With the whole country in lockdown, the UK property market is closed for business. John Stepek looks at what that means for UK house prices, housebuil…
27 Mar 2020

Oil shoots higher – have we seen the bottom for the big oil companies?

Just a few days ago everyone was worried about negative oil prices. Now, the market has turned upwards. John Stepek explains what’s behind the rise an…
3 Apr 2020
UK Economy

How the coronavirus pandemic is killing cash

Covid-19 is making a huge difference to the way we live, work and do business. One of its less obvious effects, says Merryn Somerset Webb, is to accel…
31 Mar 2020