Yield Curve Steepens – There has been a decided shift in global bond markets, a research report from Macquarie noted. While the central banks around the world have traditionally influenced the short end of the yield curve, the noted shift in longer-dated maturities cuts a stark contrast with the global economic landscape. What are the probabilities behind the long-end yield jump? While some analysts are clear — the outspoken Jeffery Gundlach has a clear performance driver in mind — Macquarie considers multiple factors and is nuanced.
Yield Curve Steepens – The long end of the bond market is rising at a time negative rates are being questioned and fiscal stimulus considered
Interest rates have been precipitously rising on the long end of the yield curve, Macquarie noted in a September 16 report.
The widely-watched 10 Year US Treasury was yielding 1.5% on September 6 and has jumped to 1.7% today, a relatively large move on a relative basis. German government Bunds, which have been flirting with negative yields, have seen a 0.2% since July and are now – gasp – positive. Even Japanese government bond yields (JGBs) moved positive after the Bank of Japan’s Wednesday announcement that it was targeting zero percent interest rates – not negative rates.
Macquarie points out it’s not just the major developed economies witnessing a steepening curve – 42 of the 45 bond markets the firm monitors have seen long yields rise while the short end of the curve is relatively tame.
The move needs to be put in perspective. While any back-up in rates should be monitored as “a large move in yields would have far-reaching implications in finance,” creating market “shock,” the interest rate move thus far is a small blip on the larger historical picture. The issue for bond market experts such as Larry Fink, speaking on Bloomberg TV this morning, is that the economy is coming off controlling measures to a level never before seen. Like Gundlach, Fink said at some point the markets will break, it is just a matter of when. The steepening of the yield curve, like any material move, needs to be carefully considered, as numerous leading analysts have pointed out.
Why is the steepening move taking place? That depends on who you listen to.
Speaking on CNBC yesterday, Gundlach said the steepening of the yield curve had significant meaning. He clearly pointed to the mounting chant for fiscal policy to be implemented that is causing concern as a new pitcher in this game needs to help tame the populist monster. While Fink noted today that instead of the central bank building up trillions in debt that benefited asset holders, for lasting economic growth the tools used to improve the economy should be more broad-based.
Gundlach is looking for downside volatility to develop in the market, its just a matter of time. Yesterday he said the yield curve was steepening due to concern over fiscal stimulus making government budgets less sustainable. The switch to fiscal rather than unconventional monetary policy is due to a realization.
“There’s a growing awareness in Europe and Japan and I think indeed in the United States that these policies have not generated the results that they were designed to generate,” Gundlach said.
Yield Curve Steepens – Macquarie is nuanced as it points to multiple potential performance drivers including fiscal stimulus
Macquarie’s analysis was more nuanced if not less conclusive. The considers four major causes of the move in interest rates – inflation, growth, short-term rates and monetary policy, credit-worthiness — each with different levels of probability and importance.
To consider inflation, consideration is given to relative value between US Ten Year note yields and Treasury Inflation Protected Securities (TIPS). The rise in yields raises the “possibility” that inflation is a reason, but not a likelihood as the spread between rising nominal yields and TIPS has been relatively flat.
There is also a possibility of improved economic growth expectations is driving the rise in yields, but this doesn’t correlate with the tepid if mixed economic numbers in the US and Europe.
Short-term interest rates are traditional the monetary tool of choice among central bankers. The report, considering modeling of how loose central bank monetary policy will be over the next ten years, is inconclusive. With interest rates negative across much of the developed, how can analysts over the next year let alone the next ten years. The Bank of Japan, for instance, “is seen as puzzling over what it can do next.”
That question, what comes next, leads to concerns over fiscal stimulus and credit worthiness. The report notes that there is concern regarding fiscal stimulus leading to instantiable government budgets. With slow growth in Europe, particularly in Spain & Portugal given as examples, a probability for the recent rate increases could be due to creditworthiness concerns.
In the end it is difficult to peg exactly why rates have been increasing, Macquarie notes, setting up a cloudy forecast. It is likely a combination of issues, including potential inflation expectations, economic growth and fiscal policy concerns are a potent mix behind the long-term rate rise. The report did not assign particular values to the probability analysis and the lack of clarity outlined the issue but didn’t give it the definition that came from the anointed bond king.