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.
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.