Top Movers

BoE caught out on a limb as sovereign bond yields rise?

By Alex Bueso - Editor-in-Chief

Date: Friday 16 Aug 2013

BoE caught out on a limb as sovereign bond yields rise?

Long-term sovereign bond yields rose notably across the globe in the past week. In particular, rates in the U.S. seem to be advancing faster than expected, apparently lifting the cost of capital world wide. Ironically, that is a testament to the better than expected health of that economy, the world´s largest. Yet in the very short-term it may push rates higher more quickly than desired by policy-makers in other geographies, such as the Eurozone and the United Kingdom.

So much so in fact that it may yet force the Monetary Policy Committe´s [MPC] 'hand' on the question of further quantitative easing, according to some observers, although for now the emphasis from analysts seems to be on a strengthening of so-called “forward guidance.”

There are also those who believe that excessive strength in Sterling is as yet unjustified. One such expert is Bill Hubard – Chief Economist at Markets.com.

As of 18:00 PM on Friday evening U.S. 10 year Treasury yields were at 2.82%, a two-year high. Benchmark bid-yields last closed above this level at 2.858% on the 29th of July 2011, according to Tradeweb.

That came on the back of another positive surprise, Stateside, on Thursday. Data showed that over the last week initial unemployment claims dropped to an annualised rate of 315,000, their lowest since October 2007. In parallel, the latest consumer price data [CPI] came in as expected, assuaging the fears of disinflation which exist in some corners.

Interestingly, both unemployment and inflation are ´lagging´ indicators, so the ´bears´ [for fixed-income] may be over-extending themselves. However, when looking out to the medium-term the fact remains the U.S. is widely thought to have turned a corner some time ago. Furthermore, some economists´ estimates for second-quarter economic growth in the States have veered sharply into positive territory of late. Barclays Research, for one, now estimates that economic activity expanded at a 2.4% annualised pace during that time interval, versus the 0.5% seen only two month´s ago courtesy - chiefly - of a much better than expected reading for the country´s trade balance in June.

No surprise then perhaps that the latest Bloomberg consensus shows roughly two-thirds of analysts factoring a start to the tapering of the Fed´s asset purchase programme in September, versus the only 50% which expected that to occur thirty days back.

Naturally, as the American economy rights itself it will support growth elsewhere. Hence the improvement in expectations for economic activity - with the important derivative of lessened financial tensions [note the recent outperformance by Eurozone periphery debt markets] - world-wide.

And who can pay the highest price?

Unfortunately, a somewhat negative side-effect of the above is that capital moves towards where it can obtain the highest rate of return. At the moment the biggest and strongest economy in the world, and with the most developed capital markets, is still the U.S.. Further, history shows that when its economy is firing on all cylinders the U.S. tends to attract capital at a voracious pace, mitigating some of the benefits to the rest of the world arising from higher imports to it.

Gilt yields dragged unjustifiably higher?

Not to be missed in that regard is the fact that over the last five days yields on 10 year Gilts have rising to the 2.70% mark, from 2.46%, also rising to two-year highs. German long-term interest rates also hit an 18 month high that day.

Much as in the U.S. said rise in rates points to confidence on the part of economic agents. Thus, at the start of the month the National Institute for Economic and Social Research [NIESR] revised its forecasts for economic growth in Britain higher for this year and next. The 'think-tank' now expects the economy will grow by 1.2% this year, and by 1.8% in 2014, three tenth´s of a percentage point more than had previously been estimated.

However, such an increase in yields, particularly if it were to continue, could have a pernicious effect on the U.K. economy. Precisely in that regard, analysts at Morgan Stanley on Thursday wrote to clients saying that: "Tighter financial conditions are the last thing the Bank wants and, as such, we believe that Carney will attempt to verbally push back market pricing over the coming weeks."

To make matters worse, Sterling has historically strengthened alongside a strong U.S. economy. Additionally, exports to the States still account for a very large proportion of Britain´s sales overseas - IMF data shows - and as is well known there is a desire on Downing Street to 're-balance' the economy.

One must also take into account that there are still non-neglible risks surrounding prospects – especially - for the Eurozone´s economy and even further afield, in China.

Perhaps more irksome, markets may implicitly be asking if the MPC may not have backed itself into a bit of a corner to the extent that it expects unemployment to come down more slowly - and inflation to rise less quickly - than markets do. Simply put, in the short-term (but not so in the medium-term) they may be on to something.

Even so, and as Danske Bank explains to clients, in general liquidity is expected to be ample for a very long time, with policy rates in the US and Europe on hold at least until 2015. Therefore, the search for yield and money going into risk markets is likely to continue in the medium-term.

..

Email this article to a friend

or share it with one of these popular networks:


Top of Page