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Central banks are depressing (yields)
Posted by
Izabella Kaminska on Sep 09
Stephen Lewis at Monument Securities is trying to rationalise the ultra-low state of government bond yields.
It all started on Wednesday, when he pointed out that current long-dated yields in the US and in the UK are now lower than they were during the Great Depression.
And as he states, this completely contradicts what equity markets are signalling, and what history tells us.
Of course, there is the fact that the market may be betting that deflation will be less damaging to corporate profits than inflation was in the 1970s and 1980s. The second point, though, is that bond yields during the Great Depression may have actually been too high. As Lewis notes:
If government bond yields are now below their 1930s levels, that may merely show how yields were then too high. The way the economy behaved at the time, with sharp multi-year falls in prices and activity, suggests they were. A 10-year government bond yield of, say, 2.50%, as a rough estimate, is consistent with a 2% real return and small positive inflation over the 10-year holding period. What is unreasonable about that, an investor might ask. In Japan, where expectations of annual price falls are now well-entrenched, the 10-year yield has been hovering around 1.00%. So, the argument runs, current yields on US, UK and German government bonds are justified, even if they happen to be historically low.
But as he states again on Thursday, generally speaking, the fundamental economic case for such paltry yields is not at all watertight.
Which suggests, as many have already suspected, the yield situation is solely the result of central bank intervention, and their ongoing rhetoric discussing extended periods of low rates.
As for the relationship with equities, Lewis makes this interesting point (emphasis ours):
Neither the Fed nor the Bank of England has trusted to this mechanism to deliver the low long rates they are targeting. This is why they have sought to reinforce downward pressure on longer-term bond yields through their QE operations. Bond yields that are lower than warranted by the fundamentals are, in turn, exerting a downward pull on other market yields, including those on equities.
They are contributing to the relative resilience of equity prices. This support would presumably evaporate if the Fed and the Bank of England were to shift to less interventionist stances with respect to the capital markets.
The danger in a situation where the authorities override the operation of market forces in setting yields on longer-term bonds is that these yields no longer function efficiently as signals in the allocation of capital. It is, indeed, a tacit assumption the authorities are making that, following the crisis, the capital markets’ function is impaired in that, left to themselves, they would not clear at low enough yields. In our next briefing, we shall examine the problems that are likely to arise with this market manipulation.
In other words, you might as well ignore what bond yields are saying, since they’ve become irrelevant due to the level of manipulation. Although, didn’t
we always know this is what the central banks were attempting to do?
FT Alphaville Central banks are depressing (yields)
