Talk­ing Fi­nance

Me hr no ch al se inv er lang s amt esWi rt sch aftswa ch stu mu nd ein durch Strafzölle dro­hen­der Han­del­skrieg macht In­ve­storen derzeit die En­twick­lung der Ren­diten für An­lei­hen Sor­gen. IAN MCMASTER erk­lärt, was es damit auf sich hat.

Business Spotlight - - CONTENTS -

Yield­ing to pres­sure?

Is the world head­ing for a re­ces­sion? The Chi­nese, Ger­man and US economies, although still grow­ing strongly, have at times all shown signs of a slow­down this year. And the threat of a po­ten­tially dam­ag­ing trade war hangs in the air. But it’s the signs from the bond mar­ket that are spook­ing many in­vestors. The US cen­tral bank, the Fed­eral Re­serve, or “Fed”, has in­creased its key in­ter­est rate seven times since the end of 2015. Fur­ther in­creases are ex­pected this year, as the Fed seeks to re­verse the easy money pol­icy that fol­lowed the fi­nan­cial cri­sis of 2007–8. A num­ber of other cen­tral banks, in­clud­ing those of Canada and the UK, have started to fol­low suit with mon­e­tary tight­en­ing.

One con­se­quence of the rate in­creases in the US has been to push up the yields on short-term Trea­sury bills (“T-bills”) and bonds sig­nif­i­cantly. This need not in it­self be a prob­lem for the world. Ris­ing in­ter­est rates are what one ex­pects at a time of strong eco­nomic growth.

More wor­ry­ing is what has been hap­pen­ing to the re­la­tion­ship between the yields on short-term and long-term bonds — the so-called yield spread.

Typ­i­cally, in­vestors de­mand higher yields from risky bonds than they do from safe bonds. This ex­plains, for ex­am­ple, why the spread between the yields on Ger­man “bunds” and Ital­ian bonds in­creased fol­low­ing the po­lit­i­cal cri­sis in Rome ear­lier this year.

In­vestors also typ­i­cally de­mand higher yields from longert­erm bonds than they do from short-term bonds. This is to com­pen­sate them for giv­ing up their money for longer pe­ri­ods and for the risk of in­fla­tion, which re­duces the real value of bonds and their in­ter­est streams.

The nor­mal yield curve, there­fore, shows an in­crease in in­ter­est rates as bond terms in­crease. Re­cently, how­ever, this curve has flat­tened in the US, as the dif­fer­en­tial between short-term and longer-term yields has fallen sig­nif­i­cantly. Ten-year bonds, at around three per cent, have been yield­ing lit­tle more than twoyear bonds.

Such a flat­tened yield curve — or, more dra­mat­i­cally, an “in­verted” yield curve, with higher short-term in­ter­est rates than longer-term rates — has tra­di­tion­ally been seen as a sign that a re­ces­sion is around the cor­ner, as it im­plies that in­vestors ex­pect lower growth and lower in­fla­tion in the fu­ture.

New Fed boss, Jerome (“Jay”) Pow­ell, re­mains san­guine about the flat­tened yield curve and plans to con­tinue the Fed’s pol­icy of in­creases in short-term in­ter­est rates. But also back in 2006, the Fed — then un­der the lead­er­ship of Ben Ber­nanke — was un­fazed by the last in­verted yield curve. And we know what hap­pened shortly there­after.

IAN MCMASTER is edi­tor-in-chief of Busi­nessSpot­light. Read his reg­u­lar blog on global busi­ness at www. busi­ness-spot­light. de/blogs

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