Yield curve weirdness

Yield curves have gone mad. Negative yields are everywhere, from AAA-rated government bonds to corporate junk. Most developed countries have inverted yield curves, and a fair few developing countries do too:

(chart from worldgovernmentbonds.com)

Negative yields and widespread yield curve inversion, particularly though not exclusively on safe assets. To (mis)quote a famous pink blog, this is nuts, but everyone is pretending there will be no crash.

Here, for your enjoyment, is an à la carte selection of the most lunatic government yield curves. You can find lots more here.

Exhibit 1: Switzerland.

Negative yield already extends beyond 30 years, and markets are pricing in further interest rate cuts and/or QE, or indeed anything to stop the Swiss franc appreciating as scared investors pile into CHF-denominated assets. Hence the curve inversion.

Exhibit 2: Denmark.

Every Danish government bond currently circulating in the market is trading at a negative yield. And the inverted curve tells us that markets are pricing in further interest rate cuts, most likely to hold the ERM II peg when the ECB cuts rates and re-starts QE. (Yes, it's when, not if  - see Exhibit 3)

Exhibit 3: the Eurozone

Eurozone aggregated government yield curves as at 18th July 2019 (chart from the ECB):

The solid curve shows us that investors will pay Eurozone goverments with triple-A ratings to borrow for 15 years or more. Here is the Netherlands, for example:

So far, so weird. The dashed curve shows us that investors will even pay Eurozone governments with much lower ratings to borrow for a few years. Here is Portugal's yield curve:

Admittedly, the yield is depressed by ECB QE, but it is still ridiculously low for a triple-B rated sovereign.

Even more weirdly, Greek bonds are trading at only 1-3%:

Greece, you may recall, defaulted on its debt to the IMF in 2015, and its private sector debt was coercively restructured in 2012. And Greece wasn't even included in the ECB's QE programme. This is totally nuts.

Returning to the Eurozone aggregate curves, the 0.5% negative yield at the short end of the "all bonds" curve suggests that markets expect the ECB to cut the deposit rate further into negative territory. And the fact that the AAA curve is inverted, but the "all bonds" curve is not, is in my view a clear indication that markets expect the ECB to re-start QE. Though why on earth the ECB should help Germany and the Netherlands to borrow at negative rates is beyond me. There is no evidence that these countries would use that opportunity to borrow more to invest. Appeals from central bankers and the IMF for them to relax their unhelpful fiscal tightness are falling on deaf political ears. They are determinedly running fiscal surpluses and reducing debt issuance at all maturities. All ECB QE would do is help them reduce their debt even more quickly. This is not remotely productive.

Admittedly, ECB QE does reduce yields on periphery bonds, which helps make the debt of countries like Portugal more affordable. But Portugal can already borrow at negative rates for five years. What on earth would be the point of depressing its yields even more?

What is really needed is for the Eurozone to end its over-restrictive deficit/GDP and debt/GDP limits, which force governments to undertake pro-cyclical fiscal consolidation and sacrifice much-needed investment. Alternatively - or better, simultaneously - create a Eurozone-wide "safe asset" that can be sold to investors, and use the proceeds to pay for the investment that governments cannot or will not undertake. But we seem a very long way away from either of these at the moment.

If expansionary fiscal policy continues to be notably absent in the Eurozone, could the ECB do anything to relieve the drought other than rate cuts and bond purchases? Of course it could. It could buy corporate bonds and equities - though it is unclear why the ECB should subsidise European corporations, if Eurozone governments can't. Alternatively, it could transfer money equally to households all over the Eurozone, which in my view is a much better idea. But we seem a very long way away from anyone at the ECB seriously considering helicopter money. Apparently they would rather experiment with wholly untried negative rates and even more distortionary QE than give people money. Some unconventional monetary tools are much more equal than others.

Exhibit 4: the U.K.

Yeah, I know, Brexit. Actually I think this is the only reason the yield curve is above zero despite its short-end inversion. If it weren't for Brexit, the UK would be sliding into negativity like the rest of Europe. Brexit raises sovereign risk and hence gilt yields. I am not sure this is anything to be proud of. I also don't think the inversion has much to do with Brexit. It seems of a piece with the general trend in developed countries.

Exhibit 5: Japan

Gone are the days when Japan was the poster child for yield curve weirdness. This looks almost normal compared to European curves:

But Japan is now the poster child for Yield Curve Control. Hence the flat yield curve. It's a feature, not a bug. The slight inversion suggests that more monetary easing is on its way. No-one seems that bothered, frankly. Japan is....negative. Everyone knows that. It's normal.

Exhibit 6: the U.S.

Am I the only person who thinks it is completely insane that the 10-year US Treasury yields the same as the 10-year Greek government bond?

Anyway, just look at that inversion. The Fed is way out of line with other central banks. The dollar is soaring and the President is cross. Surely the Fed will cut rates any day now.

And now we move on to the real weirdness.   

Exhibit 7: Hong Kong

Well, the short-end spike could indicate a liquidity shortfall due to a short squeeze, I suppose. But even without that, the yield curve is predicting lower rates well into the future. Global trading gloom, perhaps. Or uncertainty about Hong Kong's future?

And finally.....to everyone's relief, yield curves are behaving completely normally for some countries:

Exhibit 8: Egypt

Fully inverted. Likewise for Mexico, Argentina, Turkey and Venezuela. It's nice to know that yield curves can still flag up basket cases. Well, developing country ones, anyway.

But Western markets have now become the negative-carry universe that some of us predicted years ago. And the yield curve inversions go hand-in-hand with this. We do not fully understand how negative rates work, but I have long thought that once fully negative yield curves become "normal", so too will yield curve inversions. Those who want to adopt negative-rate policy as a monetary stimulus tend to assume that people will behave in the same way when rates are negative as they do when they are positive. But if, as I think, negative rates create a distorted mirror image of our familiar positive-rate world, I would expect that people's response to them would similarly be a distorted mirror image of their present behaviour. If so, then the longer negative yields persist, the more inverted yield curves will become.

Does this necessarily mean there will be a recession? Possibly. We are not yet sufficiently deep into negative rates for yield curve inversion to be "normal". But eventually, if we continue on our present trajectory, a positive-sloping yield curve will become the recession warning for most Western countries. By then, the weird transformation of our financial system that is already under way will be largely complete. No doubt this will be music to the ears of those who hate banks, but I remain unconvinced that it would be any better for undergoing such a sea-change. It could conceivably be a lot worse. Be careful what you wish for.

Related reading:

Yup, negative rates were a really bad idea - FT Alphaville
When governments become banks
Weird is normal


  1. if you want to keep your cash in a safety box you have to pay for the service, same goes for gov bonds

  2. In "normal" times when yield curves slope up, banks borrow short at lower rates to lend long at higher rates.

    When yield curves invert, banks borrow long at lower rates to lend short at higher rates.

    Greek bonds are still higher than US Treasury yields if you include the cross-currency basis.

  3. Two comments:
    a) creating a € denominated safe asset requires first making the € a "safe currency". This is impossible as long as the risk of redenomination (break up of the €) persists and the difficulties of the Eurozone to complete its integration show how difficult that is.

    b) maybe the weirdness of the yield curve and the negative interest rate s reflect the likelihood of severe currency risks ahead : the willingness of the US to weaponize the USD within the framework of its trade disputes makes the dependence of the world's financial markets stability on the FED's preparedness to be the lender of last resort in USD (as it did in the 2007-9 financial crisis) a real question not playing the mark. I wonder if actually many investors are - for the time being - liquid foreign exchange market as the ultimate hedge to protect the incredible wealth accumulated recently in both equity and bond markets and that this is driving the apparent irrationality of the yield curve?

  4. IMO, the criticism of negative rates should bring it back to issues for the overall economy, particularly inflation and unemployment. Unfortunately, the focus on inflation loses the thread. When we say the Eurozone or Japan cannot "create inflation," we really mean they cannot "create demand" or cannot "create NGDP."

    2% inflation targets instead of 0% inflation targets exist solely because 0% inflation generally means lower increases in demand/NGDP. Therefore more companies and industries have declining revenues and will cut workers or hours instead of cutting wages.

    While there is intense criticism of negative rates from outlets such as Alphaville, I can't see the issues *purely* looking at inflation, unemployment and NGDP data. For the Eurozone, for example, Eurozone NGDP levels went up only 1.7% from 1Q 2008 to 1Q 2013. That's not the average rate, but the change in level. The compounded annual NGDP increase was only 0.3%. In contrast, the Eurozone NGDP from Q1 2013 to Q1 2019 went up 19.4%, or 3% as annual compounded rate. For unemployment, this has meant a decline in unemployment from 22% to 13%. Ages 15-64 employment to population in Spain has gone up from 54% to 64% (which still seems crazy low).

    Similar kinds of numbers exist for Japanese NGDP/unemployment since negative rates and aggressive QE.

    So I guess just don't see the tremendous harm of negative rates/QE outside of, um, bank profits and returns to savers. I don't want to harm the banks just to harm the banks, but also institutions such as ECB and BOJ are ultimately government entities to serve a public purpose. The use of their mainframes or paper notes at 0% rates is not necessarily a right.

    The equilibrium everybody wants is higher real interest rates, increasing demand and inflation, without some sort of unacceptable fiscal debt. But due to the very high savings rate in EUR, CHF or JPY countries, that equilibrium just does not exist. So I suppose I would much, much rather have these strange looking negative rates and curves than have a deflationary depression. A sufficient fiscal stimulus may be the best course, but if that's not on the table, then I prefer the post-2013 NGDP growth with the QE and negative rates.


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