Rising bond yields – winners and losers

25/04/2018

| 25-04-2018 | treasuryXL |

It is the talk of the town – US 10 year Government bond yields are rising and testing the perceived psychological level of 3 per cent. At the same time the whole yield curve is flattening – the spreads are diminishing. There are growing concerns about rising inflation, along with fears of trade wars and rising oil prices. When the threat of inflation occurs, there is a selloff in bonds and their yield goes higher. At the same time as the yield curve is flattening there is talk of the yield curve becoming inverted which, historically, is seen as the precursor to a recession. Conflicting signals – what does it all mean?

The rise in bond yields is a global trend – the same is being seen in Europe and the UK. In the last week data from the EU zone showed that the economy appears to be slowing down – or increasing at a slower rate than was previously seen. However the effects of Quantitative Easing programmes in the different countries has led to a great divergence in rates.

  • For the period from 1999 to 2008 the average 10 year bond yields were as follows:
  • Germany 3%
  • United States 8%
  • United Kingdom 8%

 

  • For the period from 2008 to 2018 the average 10 year bond yields were:
  • Germany 7%
  • United States 5%
  • United Kingdom 5%

However at present the yields are 0.6% for Germany; 3.0% for United States; and 1.5% for United Kingdom

It is clear that the due to this large divergence the effects of rising US bond yield will have a very large impact on bond yields in other countries and the exchange rates.

Recession?

Classical economic theory states that inverted yield curves are a sign of recessions and down turns in the economy. Yield curves invert when the short term rates exceed the long term rates. However an inverted yield curve is not the cause of a recession. As the Fed has been pursuing a policy of gradual interest rate rises, it is not unrealistic to expect that to lead to a tightening over the whole curve. As investors expect short term yields to rise – leading to an eventual rise in long term rates – their area of focus changes and they position themselves by selling long dated bonds, causing a rise in long dated yields.

At the same time market analysts are saying that the global economy has reached a new departure point – there has been a significant shift in interest rate perceptions and that whilst rates can and will rise, they will not revert to the mean. However, as investors chase yield a major rise in US bond yields will impact on other bond markets. When the US bonds are yielding 400% more than their Eurozone counterparts, there are serious worries that investors will flock to the US market, unless the ECB announces the end of QE, which would lead to rising Euro yields.

There is also a possible knock on effect to the equity markets. Rising bond yields suddenly make equities less attractive. It could be that volatility is about to return and that Treasurers will need to look at their hedging policies.

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