One of the most intriguing developments of the credit crunch era has been the development of trends in interest rates and bond yields. It has been along the lines of the aphorism that those who have some will get more and those who have little will not. We now live in bond yield terms in what is something of a bi-polar world and it would appear that Rudyard Kipling’s phrase “never the twain shall meet” is an apt description. And in addition I am sorry to report that economists have often rushed to put their flag on one of the poles and claim that it means their theories are correct conveniently forgetting the existence of the other pole.
What do you mean by a bi-polar world?
Examples of one pole are given regularly on this blog as I recount borrowing costs in the peripheral nations of the euro. This morning the Spanish and Italian ten-year bond yields are both over 6% at 6.73% and 6.08% respectively. They find themselves facing bond yields which are best make debt financing expensive and also ones which if they are sustained will make them insolvent.
We do not have to leave Europe to see examples of the opposite pole. Germany is an example of this but so is the UK and the most extreme case is Switzerland. This morning the German ten-year bond yield is at 1.25% and the equivalent UK Gilt yields 1.53%. I had to be careful with the decimal place for the UK because in my career it has been ten times the current amount! You may need to be sitting comfortably for the next bit as in Switzerland we see a ten-year yield of 0.53%.
One corollary of this is that countries at one pole can borrow extraordinarily cheaply. In the past week or so three countries have issued ten-year debt at record interest rate lows or if you prefer price highs. The UK at 1.72%, Germany at 1.31% and if we extend our geography to anothe case the United States at 1.46%.
The Economic Consequences of this
We see circumstances where monetary policy appears impotent.
If we examine my country the UK we saw official interest-rates cut to 0.5% over 3 years ago. And if we examine the Libor scandal there seems to have been further pressures on semi-official interest-rates too. Added to that we have seen bond yields plummet and the Bank of England try to pump cash into the economy as well via the £328 billion of Quantitative Easing it has indulged in. It will try again with another £1 billion this afternoon. And of course there is the new bank subsidy scheme called “Funding for Lending”.
On the other side of the coin we see this from the National Institute for Economic and Social Research which I reported on last week.
Nevertheless, these figures suggest that the UK economy remains broadly flat; a trend that has persisted for around 24 months.
So we see evidence for a modern version of what John Maynard Keynes called a “liquidity trap” where (further expansionary) monetary policy becomes ineffective. When this was conceived I am not sure that economists differentiated between short-term interest rates such as the UK base rate and bond yields much if at all. However I think that both are now at levels where we are in a liquidity trap. I have argued much of this before but the further plunge in bond yields in 2012 seems to have reinforced this. The past falls in the credit crunch era should have helped more than they have so this years are unlikely to help the economy much if at all. I also worry that via demonstrating the seriousness of the situation there is an undercurrent or backwash effect on confidence and expectations.
In essence it all comes down to the question why are we not doing better than we are? And we can widen this to the United States as evidence of a slowing down there builds.
Negative bond yields are spreading
Another trend which I pointed too on Friday is the spread of negative yields. We have had negative real yields in many places for some time- where likely inflation exceeds the interest-rate received- and official policy has been in general to drive real yields below zero. But we are seeing more and more ordinary or nominal yields drift below zero.
Switzerland is the most extreme case currently where even her five-year bond yield is negative this morning at -0.025%. Marginal maybe, but five years along the curve…. Could her ten-year yield go negative too? That would be quite something. It would not be much fun being a saver in Switzerland would it? It would be fascinating to see the level of savings and borrowing that was stimulated. As we stand the most negative number is the Swiss two-year yield at -0.425%.
This issue has surfaced in Germany too as her two-year yield has fallen to -0.05% and her three-year yield has drifted below zero too. Investors are apparently willing to get back less than they invested to get the security of the stamp of the Federal Republic of Germany on their investment. We will have to see if they are right that the two to three year zone presents a particular danger.
Last week France issued short-dated paper (Treasury Bills) at a negative yield. Now I do not wish to be responsible for breaking up what remains of the Entente Cordiale but I somewhat doubt investors are rushing for the safety of La Republique. So whilst it is also unfair to say that they are going for any port in a storm there are worrying implications here. Firstly why are investors doing this? Secondly and potentially very disturbingly are they right to do so?
So we see that France is added to the list of those with negative yields (Switzerland, Germany, the Netherlands, and Denmark). As I type this I see that two are missing one glaring and one less so. After a “lost decade” now stretching to twenty years why doesn’t Japan have them? And as we are using our independent monetary policy pretty much to the max why doesn’t the UK? Of course we share with Japan the use of Quantitative Easing or QE and so we face the possible question has it actually reduced bond yields and could it have raised them (higher than they would otherwise be) at the short -end?
If we return to the theme of a bi-polar world we return to Spain and Italy which have two-year yields of 4.46% and 3.58% respectively. There is no hiding place for them right now and anyway shorter-term borrowing has its own dangers and the time you have to borrow again comes around ever faster.
But we find ourselves facing a simple question. If we consider the poles of the Earth which I gather do switch every now and then ( so much for GPS and sat-navs I would imagine) what makes a country switch poles? As I make a list of likely candidates (economic prospects, debt levels, fiscal deficit levels) I realize that I am making a case that my own country the UK should have switched over already. Ooops! And we are left clinging to our independent monetary policy like a raft in a flood hoping that as we go downstream we do not come across a waterfall.
Perhaps even the European Central Bank wants a stake in this game
Whilst its headline rate was cut to 0.75% the week before last this also happened.
Deposit facility 0.00 %
Not much fun putting your money there is there? But should they cut again-which they will come under pressure to do- consider the implications….. An official interest-rate going negative would break new ground.
We face many implications from what is happening to interest-rates right now. But let me contrast the last few years with the previous twenty or so of my career. You see that in the UK -as well as many other countries- bond yields have been falling overall for the period of time. It provided quite an economic boost for this period but was not reported much. After all it is something that politicians find it not easy to take the credit for! But nonetheless it was there across the late 80s,90s and 00s and we may have to face the possibility that we have already taken the benefits to be gained from it and that we will find little more to be had whatever we do.
As for the consequences of going negative I am more sanguine than some. But I have to confess a lot of that is due to the fact that I believe (and hope…) that it will prove to be temporary. However as ever that word temporary is lasting longer than one might have thought! And before this phase passes we are likely to see more places join the list and the negative interest-rates themselves rise.
For those wishing to look at the development of my thoughts in this area here are two previous articles for your perusal.This article was written by Shaun Richards and originally published on Mindful Money under the title: Are negative interest-rates and bond yields a benefit or a curse?
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