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OPINION

Back off!

Back off!
September 1, 2016
Back off!

Phrases like: 'bond rally buckling'; 'Bunds escape negative territory'; 'monetary policy reached its limits'. What they have in common are biases. These are: 1) interest rates are too low (implying that they should be closer to 4-5 per cent). 2) That the bond buying bubble will end in tears – imminently. 3) That economists know better because theirs is a serious, well-established discipline.

One at a time. Ten-year UK gilt yields (forget about central bank target rates as these are often irrelevant) held between 4 and 5.5 per cent in the 10 years starting 1998, as did US Treasuries (plus during 1959-67). German Bund yields similarly from 1997 to 2008; Japanese government bonds (JGBs) only from 1992-95. This is not the natural rate of interest as, for the rest of the time, yields have been either well above - UK and US peaking over 15 per cent in 1981 - or below this band. Anchoring bias ahoy!

 

Ten-year gilt yield

 

The back-up is so dramatic because of the laws of tiny numbers. Both 10-year Bunds and JGBs moved from -20 and -29 basis points to zero; that's a 100 per cent move in their interest rates. Look at the charts of their benchmarks and price moves are a small, but not inconsiderable, fraction of that. US Treasury 10-year saw a 25 per cent reversal and gilts 75 per cent, again because the latter started from a record low 50 basis points in August.

 

Bund future

  

JGB future 

 

Yields can remain low - or too low many say - for ages. Witness the 10-year JGB that has continuously yielded less than 2.5 per cent since 1997. And we remind that UK Consols yielded between 2.5 and 3.5 per cent throughout the century starting 1815. Perhaps one should 'hope' for slowly inflating yields rather than a bubble bursting.

The other bias to be addressed is that economists, and central bankers in particular, know what they're doing. Let's face it, they are only human, and just like all of us have their 'vanity projects'. The overriding one is that they 'fixed' the great financial crisis. Recently the Swedish Riksbank was the first to succumb, raising its key rate from 25 basis points to 200 starting April 2010 - because "all was well". Since 2012 they have cut it steadily, following Switzerland into negative territory in February 2015.

Jean-Claude Trichet, president of the ECB, fell into the same trap, as he was about to be forced into retirement. So starting April 2011 his team moved from 25 to 75 basis points on the deposit rate, his swansong. Oh dear and now Mario Draghi has become another negative commando.

 

Ten-year US Treasury yield