Divergence in Volatile Global Bond Yields
(This
is for information purposes only. This should not be construed as a
recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial
adviser before taking any investment decision. Safe to assume the author has a vested
interest in stocks / investments discussed if any.)
Global bond yields surged in the past one month with market volatility rising globally. The Federal Reserve, central bank of the US, last week hinted that it would continue to raise interest rates to anchor inflationary expectations in the US. After 18 months of increasing rates, the Fed last week held interest rates the same.
This is seen by markets as hawkish prompting bond investors to sell bonds with reverberations touching stocks and precious metals.
When central banks raise interest rates, bond prices fall. When prices fall, bond yields rise. Bond yields and prices have inverse relationship.
Even though consumer price inflation (CPI) rates have come down in recent months, major central banks continue to raise benchmark interest rates with a few nations holding them steady.
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Real interest rates
Table 1 shows 10-year bond yields, policy interest rates, inflation and real interest rates of 15 major nations.
Compared to six months ago, more countries have positive real interest rates. The US, Brazil, the Netherlands, Russia, China and Switzerland have positive real interest rates as of now -- this is because central banks continue to hike rates even as inflation rates are down.
Turkey is bizarre here. It decreased interest rates in the first half of this year even as inflation rose to as high as 85 percent. After Erdogan re-elected as president in May2023, Turkey started increasing interest rates to control inflation.
Inflation rates
Table 2 delineates changes in consumer price inflation (CPI) rates in the past six months.
Except India and Turkey, major nations have been able to control inflation to some extent. Severe monetary tightening seems to have helped in anchoring inflationary expectations in these nations.
In the US, CPI inflation rate is down 234 basis points (100 basis points equal one percentage point), while in the UK it is down by 370 basis points.
Though inflation seems to be under control for now, central banks are expected to maintain their hawkish monetary policy stance for longer period of time.
Divergence in bond yields
In the past one month, global bond yields spiked as the US Fed, the UK's Bank of England and Euro area's European Central Bank (ECB) are showing no signs of relenting in rate hikes.
However, there is a divergence when one compares current bond yields with those six months back. Most the the Western economies, except Switzerland, have shown increase in bond yields -- while those in Asia have shown decrease in bond yields.
Table 3 below shows the divergent trend in bond yields between developed markets and emerging economies in the past six months.
For example, the 10-year US Treasury yield rose by 111 basis points, with the Fed hiking its federal funds rate by 50 basis points (see Table 4 below) in the six-month period.
Australia's 10-year bond yield surged by 124 basis points with its central bank increasing its benchmark interest rate by 50 basis points.
Turkey 10-year bond yield rose by 15.21 percentage points, as Turkey seems to be failing in controlling inflation with its queer monetary policy stance (it decreased interest rates when inflation was north of 80 percent at the start of 2023).
However, in recent months, Turkey reversed its policy stance and started increasing its rates.
The divergence in bond yields between developed and developing economies is due to the expectation that major Asian economies may not further increase interest rates, as opposed to developed economies which are expected to continue with their hawkish stance.
One more reason could be the differences in level of government debt. Government debt in China and India, is much lower compared to those in the Western hemisphere.
Countries with high debt-GDP ratio tend to dishonour their sovereign debt -- so, to compensate for the higher risk, bond investors tend to demand higher yields.
For example, debt-GDP ratio in the US is more than 125 percent whereas in China and India, it is 77 and 89 percent respectively. The debt-GDP ratio in Euro area and Japan are 91 and 263 percent respectively. The UK, Italy and France have debt-GDP ratios north of 100.
However, bond investors globally tend to ignore high debt-GDP ratios in the US and Western Europe for other considerations. But nobody knows how long this optimistic situation continues for these nations.
Benchmark interest rates
Most countries in the sample had increased their benchmark interest rates in the past six months. While Japan and India held their rates, China and Brazil decreased their rates slightly.
China is battling an economic slowdown in recent quarters. It is unable to provide a boost to global economic growth, as was the trend in the past 20 or 25 years.
China's economic policies seem to be in reverse gear in recent years, with Beijing turning its attention to over-regulation of big technology firms based in China. Its real estate sector is in doldrums -- for example, Chinese property developer Evergrande declared bankruptcy last month.
China's population growth too has slowed down with women fertility rates down to 1.2 in 2021 as per World Bank data. (a fertility rate of 2.1 -- that is, 2.1 births per woman -- is considered as replacement rate, below which population will start to shrink).
Table 4 below reveals the changes in central bank interest rates in the past six months:
Summary
Beyond a point, higher bond yields tend to be negative for stock markets -- because higher bond yields entail increased cost of capital for households and businesses.
Major central banks, like, the US Fed, the UK's Bank of England and Euro area's European Central Bank are still hinting at further interest rate hikes in order to bring down the interest rates to their target rates. These nations are still far away from achieving their target inflation rate of 2 percent.
Financial markets seem to be battling between fears of a recession (defined as two back-to-back quarters of negative economic growth) in the US, the UK and the euro area; and the prospect of further interest rate hikes.
However, rising crude oil prices are telling a different story. Some experts are of the opinion that crude oil prices may do well amidst global turmoil -- as Saudi Arabia and Russia announced further output cuts and oil inventories are lower.
Maybe, it is time to be cautious on risky assets in the next quarter.
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References:
TE bond yields
TE interest rates
TE CPI inflation rates
TE world data
Additional data from Trading Economics (all data as of 30Sep2023):
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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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