Posted this as a comment on an Economist article:
http://www.economist.com/comment/779255#comment-779255
"I believe that the rise in yields is a powerful emergent outcome of several factors. The market has been unable to clearly distinguish between the expected monetary tightening cycles & fiscal problems of the G4. As a result, government bond yields have been correlated to an unusual degree since the Great Recession. An expansive monetary-fiscal policy mix by the US and China and confidence in global growth prospects has caused a glut of non-genuine investment demand in several commodities, including food, base metals, oil and precious metals. This has started feeding through to inflation everywhere, even in the “deflationary” G4 economies. A part of the rise in yields was also driven by a classic "buy rumour, sell fact" story post the November FOMC rate decision. Subsequently, the extension of the Bush tax cuts boosted US yields on both growth expectations and higher fiscal deficits. Which of the two the market is pricing in to a greater degree is yet to be known. The rise in yields has been greatly exaggerated by thin liquidity in December. With the extension of the tax cuts, the outlook for consumer spending and credit growth also improves. At the same time, US homeowners will suffer greatly if mortgage yields suffer a blowout. Both core and headline inflation in the US can head higher from here on, particularly if credit growth picks up and house prices stabilize due to increasing confidence. This, unfortunately, may not be accompanied by a corresponding decline in unemployment. I believe that the US and UK may have shifted to a higher NAIRU and hence will pose interesting policy challenges for the Fed & BOE. The UK has already demonstrated this with persistently high inflation over the past year or so. With fiscal and monetary measures totalling well over 3.5 trillion, whether its a debt sustainability issue or an improving growth outlook, US yields are set to continue the rise. And till the world learns to price G4 sovereign risks independent of each other, the others will continue to follow US yields."
Comments & criticism most welcome
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Hi,
ReplyDeleteThis was a very nice summary of what is likely to have caused rout in bond market in G4 countries lately. Good analysis. Keep it up.
Additionally, you might want to refer to below links which basically say that post Nov FOMC (where QE II was formally announced), rise in nominal yields has more or less coincided with rise in real yields (implying stable medium term inflation expectations)whereas the period of approx. 2-3 months prior to that (between Aug and Nov FOMC meeting) was charactrized by fall in real yields with nominal yields staying stable (implying rising inflation expectations off the recent cyclical lows in a run up to QEII annoucement in Nov).
Links are:-
1)http://macroblog.typepad.com/macroblog/2010/12/whats-behind-recent-treasury-yields.html
2)
http://macromarketmusings.blogspot.com/2010/12/jeremy-siegel-gets-it.html
Thanks,
Pratik Kothari
E-mail: pratik_kothari@yahoo.com
Thanks a lot! Your comments are very insightful. What you have pointed out with respect to the break-even yields is spot-on: The break-even yield (or difference between the nominal and real yields) trended higher pre-FOMC but has stayed largely stable post that;
ReplyDeleteWhat can happen hereon is that food and energy prices (which account for 25% of the US headline inflation basket) trend higher from here on and cause inflationary expectations to rise further. In fact, the US and Japan are probably the only two places which have low inflation. Developing economies and the UK have been facing inflationary pressures since some time and even EU overall inflation is close to 2% now YoY (though differences between the core and periphery are present)
Experts point to the weak labour market in the US and the service oriented nature of the economy to justify why core inflation is so low. Any sort of labour market recovery hence will cause inflation to recover as well.