Global Bond Yields, Negative Real Interest Rates & Soft Landing
(An update 02Apr2023 is available)
A notable feature of
financial markets in 2022 has been the talk of an economic recession and
whether major central banks will be able to engineer a soft landing in
the developed world. To know about the term 'soft landing,' we need to go back to the 1960s and 1970s.
After the World War II, there was intense competition between the United States and the erstwhile Soviet Union to conquer the space and make rapid innovations for space exploration. This competition came to be known as space race.
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In the ensuing space race, the first salvo was fired by the Soviet Union, when they launched Sputnik (unmanned flight) into space in 1957 followed by Yuri Gagarin's space flight orbiting the Earth in 1961. And the US was not behind and they sent Apollo 11 mission to the Moon with Neil Armstrong landing on the Moon in 1969.
From the space race during the Cold War came the term 'soft landing' when the US and the Soviet Union were sending unmanned probes to Mars and Venus, with some of the spacecrafts making successful soft landings, meaning they landed on the planets smoothly.
The buzz in the media now is about a soft landing for the global economy -- whether the economy will weather the economic slowdown, without large-scale job losses and a serious recession hitting businesses.
The word 'soft landing' was not used as economic jargon until mid-1990s when the US Federal Reserve, under chair Alan Greenspan, successfully engineered a soft landing, with economic growth of less than one percent was achieved without upsetting the job market and businesses in the US.
At yesterday's FOMC (federal open market committee) press conference, Michael McKee of Bloomberg TV asked Federal Reserve chair Jerome Powell: "Do you think a soft landing is no longer achievable?" Powell responded saying, "I wouldn't say that... I don't think anyone knows whether we're going to have a recession or not, if we do whether it's going to be a deep one or not, and it's not knowable."
The steep increase in interest rates this year has caused huge pain for the public. Due to rising inflationary expectations, central banks have raised their policy interest rates at a faster pace this year causing bond yields to rise and the concomitant fall in bond prices.
Investors holding long-term bonds have lost more than 20% to 25% of their value due to surge in bond yields (bond prices move inversely to bond yields and vice versa). While inflation has moved up more rapidly, the increase in interest rates is slower -- resulting in negative real interest rates for savers and bond investors.
Real interest rate is the nominal interest rate minus inflation rate. For example, inflation (as measured by consumer price inflation or CPI) rate for Nov2022 is 10.70% in the United Kingdom (UK) and the policy rate of Bank of England (UK's central bank) is just 3.00% -- providing a negative real interest rate of 7.70%.
Table 1: Showing Global Bond Yields, Interest Rates, Inflation Rates and Negative Real Interest Rates >
Of the 15 major nations, twelve have been going through negative real interest rates, with only Brazil, China and India (all emerging markets) providing positive real interest rates as of today.
All the Eurozone nations have been under negative real interest rates. Of the large economies, Turkey is a big outlier with a negative real interest rate of a mind-boggling 75%. The beauty of Turkey, under president Recep Tayyip Erdoğan, is its central bank has been cutting interest rates drastically even as inflation has been shooting up without any let-up.
Table 2: Showing how the CPI or consumer price inflation has moved year-to-date (between 31Dec2021 and 15Dec2022) >
Only Brazil and China have experienced lower inflation rates compared to the beginning of this year. Brazil has been raising interest rates, in quick response to rising inflation, much before the major central banks had started reacting. And this proved to be effective in containing inflation to a large extent for Brazil.
Table 3: Showing global bond yields and changes between between 31Dec2021 and 15Dec2022 >
All nations have undergone rising sovereign bond yields this year, except Turkey whose 10-year bond yield has come down by 13.67 percentage points this year.
Table 4: Showing benchmark policy interest rates and the changes year-to-date >
This year, there has been no change in the policy rate in Japan. While China, Russia and Turkey have decreased their policy rates, other major central banks, including the US Fed, Bank of England and European Central Bank (ECB) have raised interest rates in response to higher inflationary expectations.
To Sum Up
This year has been quite extraordinary for global markets, with rising inflationary expectations, wild fluctuations in currency exchange rates, elevated prices of goods and services, falling asset prices (except for commodities) and both bond prices and stock indices losing heavily simultaneously -- exacerbated by Russia's invasion of Ukraine and supply chain bottlenecks.
As Fed chair Powell remarked yesterday, nobody knows what happens to the economy next year. However, the US Fed has been showing all seriousness, by raising the federal funds rate by a record 425 basis points this year, to anchor inflationary expectations as per the mandate of the Fed.
It is hoped 2023 may turn out to be less volatile as compared to 2022, though global uncertainties remain for the next one to two quarters depending on the progress of anchoring inflationary expectations and a possible recession in the US and Europe.
However, investors may need to be prepared for heightened uncertainties and volatility.
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P.S.: Even as I'm writing this, Bank of England raised its benchmark interest rates by 50 basis points to 3.50% and European Central Bank (ECB) raised interest rates by 50 bp to 2.50%. The above tables do not reflect these revisions by ECB and BoE.
References:
'The Age of Turbulence: Adventures in a New World' by Alan Greenspan
Some screenshots captured on 03Jan2022 showing inflation rates, policy rates, interest rates and other macro indicators (source: Trading Economics) >
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Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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He blogs at:
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