Has the trend in falling bond yields changed?
The borrowing costs for most governments have been climbing up over the past few months. Governments that have weak credit quality have seen their borrowing costs raising sharply since the middle of the year, after several years of continuous decline. What signal the decline of government bond prices are sending to investors and what is the impact on the financial markets?
Yields on benchmark governments bonds have been falling over the past years, with German, Japanese, Swiss borrowing costs dipping below zero for the first time just before the middle of this year. However, since the second half of this year, most yields have risen sharply in some places by more than 50 basis points. This is not a massive sell off but coming from negative yields can be very painful for bond investors. The upward movements in government bond yields might be small but it is telling us that a trend in rising bond yields is on the way. This could be a trend reversal. Looking at the global political and economic back ground one would have thought that government bond yields should be going down not up. It is now getting much harder to forecast the trend in interest rates. So, why the sudden sell off in benchmark government bonds? Could it be the close call on the upcoming US election. But this should not affect bond yields that much as the Federal Reserve supposed to be in charge of the direction of interest rates.
Could US voters learned something from the British about how to vote for something which can be very vital i.e. Brexit or US presidential election. There might be a case of US voters not showing their true intention when it comes to voting for the next US president. This argument might suggest that Donald Trump could become the next US president. This naturally could upset the financial markets. I believe prudent investors are cashing their chips and waiting on the sidelines for the time being.
Trump’s unconventional approach to sound policy making is unlikely to be good news for investors and the financial markets. Most economists are questioning his policies and wondering how and what he will do if he wins the election. He seems very suspicious of the way the Federal Reserve has been managing its interest rates policies. He thinks there is a conspiracy against him. This is not good coming from a potential new US president. He needs to change his words and try to assure the global financial markets of sound economic policies.
As a result, the rise in the 10-year Treasury yield to about 1.8 percent from as low as 1.36 percent at the start of July could be evidence that fund managers are demanding higher compensation as a bulwark against a Trump victory. The recent decline in global stock markets reinforces the possibility that the smart money is moving to the sidelines until the election is decided. The prospect of higher inflation, which erodes future bond income, typically drives yields higher. And consumer prices are finally showing signs of life after coming from very low base or in some cases negative inflation.
After falling for such a long time, inflation has started to rise again and this is causing some panic among bond investors. But the consensus among economists is for U.S. inflation to surpass the Fed’s target in every quarter of next year. The U.K. is likely to show average consumer price increases of 2.3 percent next year, and even euro zone inflation is expected to average 1.3 percent in 2017, compared with just 0.2 percent for this year.
It is possible that bonds are simply responding to a change in economic fundamentals by discounting an acceleration in inflation in the quarters ahead. May be the record low and negative government bonds yields were just anomaly can now yields are rising back to where they should be in times of rising inflation. May be the European Central bank is not convinced of future inflation threat and that is why it is still doing its monthly purchases of roughly 80 billion euro of bonds. The European Central Bank is still in the market, with purchases of 80 billion euros ($90 billion) of bonds each month.
The Federal Reserve, meantime, appears poised for its second interest-rate increase in more than a decade. Prices in the futures market point to a chance of about 70 percent chance of a hike on the December anniversary of last year’s increase. No wonder the universe of bonds that yield less than zero is starting to shrink.
Bond investors are facing the potential of further sell off in government bonds. The potential reversal of Quantitative Easing policies could have a dire impact on the bond markets. Bond markets are indicating that there is a change in investors’ perception and reality towards government bonds. Bond and equity investors should be aware of the implications of rising bond yields and their impact on all sorts of investments. @Rasameel