Where are gilts going? Insofar as the past is any guide, the answer depends to a large extent upon global rather than local factors.
I say this because gilt yields have been massively correlated with overseas government bond yields. Since the inception of the euro in 1999, variations in German and US 10-year yields have explained – in the statistical sense – 96 per cent of the variation in UK 10-year yields. To put this another way, it implies that if overseas yields don’t change there’s only a one-in-six chance of gilt yields rising more than 0.3 percentage points.
10-yr government bond yields
Of course, this huge correlation is due largely to all three yields trending downwards during this time. But this doesn’t overturn the substantive point; it merely tells us that some worldwide factors have driven yields down around the world.
Bond markets, then, are globalised. What does this tell us?
One thing is that variations in medium-term economic growth are determined largely by global factors – or at least that investors believe this to be the case. The global downward trend in yields is due in part to worldwide secular stagnation and to the effects of the global financial crisis in reducing trend growth and hence interest rates. The strong cross-country correlations in yields are consistent with a claim made by Peter Robertson and John Landon-Lane, that national governments can do little to affect trend GDP growth as this is determined mainly by global factors.
Also, this tells us that inflation – or at least inflation expectations – are set globally. If inflation were a purely national phenomenon we’d expect low correlations between bonds as investors expected inflation in (say) the UK but not the US and hence different changes in interest rates in the two countries. The fact that we don’t see this is consistent with inflation depending upon global factors such as commodity prices and world aggregate demand and supply more than national ones. The fact that wage inflation has stayed low in both the UK and US despite low unemployment in both countries is consistent with this.
Another thing it tells us is that national government borrowing doesn’t much affect yields. A big reason for this is that governments can tap into the world’s pool of savings rather than just the domestic pool. And this is big. The IMF estimates that worldwide new savings will be just over $20 trillion this year. UK government borrowing is only 0.3 per cent of this. From this perspective, it’s no surprise that such borrowing hasn’t increased gilt yields.
There might, however, be a different interpretation of the data. It could be that correlations between yields have been high not just because they’ve been set by global factors such as secular stagnation and worldwide demand for safe assets but also because governments have pursued similar policies. Western policy-makers have all more or less targeted inflation, been “fiscal conservatives and monetary activists” to use George Osborne’s useful phrase, and pursued 'neoliberal' supply-side policies. Perhaps it is similar policies that have given us similar moves in bond yields.
This implies that if a national government were to break with this consensus, then its yields could move even without a move in global yields. A government determined to borrow significantly more would then see yields rise.
We have a bit of evidence for this. In recent months, the correlation between US and UK yields has fallen.
Now, this might be just a temporary quirk caused by the Federal Reserve tightening monetary policy before the Bank of England.
But it might reflect something else – that a government that breaks with the policy consensus would cause yields to rise. It might be no accident that US yields have risen relative to those elsewhere since the election of Donald Trump – because he might well increase infrastructure spending and (perhaps) make more political appointments to the Federal Reserve.
I don’t know how true this is: so far the evidence isn’t conclusive either way. However, those of you who believe that fiscal austerity is necessary to hold down borrowing costs or who fear that a Labour government would lead to a major sell-off of gilts must believe something like it.
