A fortnight ago the central banks of Britain and the United States made decisions that were (supposedly) eagerly awaited by market participants. The first, and subtler one, was whether Janet Yellen would remain as Chair of the Board of Governors of the Federal Reserve System. Her tenure ends in February 2018 and, as I understand it, unless one specifically asks to step down, the job continues for another four-year term. President Trump ditched her, she who many believe is the softest dove in the coop; strange but true.
The Bank of England’s Monetary Policy Committee met Thursday 2 November and, as loudly trumpeted and widely expected, they raised their key rate by 25 basis points. While doubling it from a record low 0.25 per cent, it reverses last year’s hasty post-referendum cut. Do they know what they’re doing? I ask because November’s Quarterly Inflation Report states: “the MPC’s central forecast, conditioned on the gently rising path of Bank Rate implied by current market yields…” So, they take their cue from the money market and bond dealing fraternity. Or as Deutsche Bank’s Aleksandar Kocic wrote recently, “the Fed knows that the market knows and the market knows that the Fed knows that the market knows, so everyone knows, but pretends that nobody knows and the game goes on”.
Let’s look at recent price action in the sovereign debt markets and try to gauge who is chicken and who is egg. Two-year gilt yields, which move inversely to the bonds’ price, were 51 basis points on the 1st of this month, suggesting market participants didn’t expect interest rates to be much higher than the then Bank Rate’s 25 basis points. Following the MPC’s decision to hike, it slumped to 39 – less than the new central bank target. The market was completely underwhelmed by the MPC’s decision, even suggesting it might have done the wrong thing, and today these yield less than 50 basis points.
At the long end of the curve the yield on benchmark 30-year gilts dropped on the 2nd of November from 191 to 183 basis points, thus flattening the yield curve between two- and 30-year paper to just 133 basis points – a lot lower than the 200 at the start of this year.
Similarly, in the US where 30-year Treasury bond yields, on which American mortgage rates are based, peaked late October at 298 basis points drifting to just 276 after Mr Trump’s decision to appoint Jay Powell as Fed chair. What’s interesting is that the back-up in yields which started in June last year, has peaked potentially for a third consecutive year around the 325 level – keeping intact the secular trend to lower yields. At 114 basis points, the spread of long-dated US paper over two-year is at its lowest since late 2007 when the global banking system started creaking. This matters because a flat or inverted yield curve often, but not always, implies recession and rate cuts ahead.
Finally, look at 10-year Italian government bond yields which have slumped from 228 to 169 basis points since October. Here the narrative is different and is because of the amount, and need for provisioning, of non-performing loans held by the country’s all too many commercial banks. Large depositors are steering clear, preferring to hold safer Italian Treasuries. Yes, really.
