Global Bond Yields and Asset Prices - vrk100 - 07Jul2022

Global Bond Yields and Asset Prices

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(An update 15Dec2022 is available)

 

Asset prices hinge on future cash flows of the asset and discount rate.

 

The discount rate is the sum of the risk-free rate, expected inflation rate and a risk premium specific to the asset’s expected cash flows. For long-duration assets, like, growth stocks, the risk-free rate is the 10-year sovereign bond yield. As the risk-free interest rate is a component of the discount rate, whenever interest rates go up, the discount rate increases and the asset price falls, provided other things remain unchanged. 

 

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Related

Global Bond Yields Surge 05Mar2022

Global Bond Yields and Interest Rates 29Nov2021

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Bond yields, especially sovereign bond yields, are the building blocks of asset pricing. It's not a good idea to look at any single market in isolation. The bond, equity and forex markets are inter-linked; not to speak of global linkages. In markets, everything is connected—wars, virus outbreaks and supply chain disruptions.

 

Fiscal and Monetary Stimulus

 

The world over, both the monetary and fiscal authorities have been following unconventional policies--with the result asset prices are not reflecting their true fundamentals. In the US, the federal government had pumped in massive doses of economic support to the citizens who were impacted by the COVID-19 Pandemic.

 

This monetary and fiscal stimulus had propped up asset prices globally. Such artificial prop-up of financial markets led to less efficient price discovery of asset prices--creating its own problems for the global economy.

 

With following ultra-loose monetary policies for several years, central banks globally have distorted asset prices. With such distortions, investors should not assume that asset prices correctly reflect their true fundamentals.

 

With central bank-led asset price distortion, behaviour of economic agents changes, which is detrimental to the economy as a whole. Investors / speculators tend to look for easy and quick returns, speculating in stock or crypto-currency markets. With fixed income giving negative real rates, investors are forced to stick to risky assets even though price discovery mechanism of risky assets is in smithereens thanks to relentless bond buying (also known as quantitative easing or QE) by global central banks.

 

With interest rates near zero globally due to the unconventional monetary policies followed by major central banks for long, asset prices had remained elevated globally. That was before the start of 2022.

 

Since the beginning of 2022, investors started to price in steep rise in interest rates (especially in the US and the UK) and global stocks had started falling steeply. As inflationary pressures (aided by Russia’s invasion of Ukraine, rising crude oil prices and global supply chain bottlenecks) remained elevated, major central banks, like, the Federal Reserve, Bank of England and others started raising their benchmark interest rates (details in Table 2 below).

 

Investors were extrapolating asset prices in financial markets would only grow higher. But with rising inflationary expectations, investors’ assumptions of financial conditions had changed dramatically in the past six to eight months, leading to steep fall in global stocks, except those in the energy sector.

 

Disconnect between Inflation and Interest Rates

Before the advent of Quantitative Easing (QE) monetary policies, there was a close resemblance between inflation and interest rates. Whenever inflation rises and falls, interest rates used to rise and fall together. There was not a big difference between inflation rates and interest rates.

 

But post-QE, the situation is different. Have a look at the interest rates and inflation numbers provided in Table 3 below. For example, the consumer price inflation (CPI) in the US is 8.60 per cent (latest available print), but the Federal funds rate at 1.50-1.75 per cent is way below the inflation rate. It is not clear how the Fed will be able to control inflationary pressures with such massive difference between inflation and interest rate.

 

The distortion is worse in the Eurozone. The European Central Bank (ECB) has kept interest rate steadfastly at zero for a long time, whereas the CPI is elevated at above 8 per cent in the Euro area. Such distortion is not helping anyone. This kind of distortion is reflecting in currency market with the Euro plunging to its 20-year low against the US dollar (one Euro is now quoting at 1.02, close to par, versus the USD). 

 

The US 10-year Treasury Yield

 

Due to the rising interest rates and higher inflationary expectations, the US 10-year Treasury yield rose by almost 200 basis points during 2022. The 10-year yield rose from a level of 1.51 per cent at the end of December 2021 to a recent peak of 3.48 per cent on 14 June 2022. Since then, the bond yield started falling and now is at 2.90 per cent (end-06Jul2022).

 

So, in the past three to four weeks, global stocks stopped their downward journey and started rising once again, though they are still down on a year-to-date basis. 

 

To sum up, asset prices and bond yields are closely inter-connected. As asset price discovery has suffered heavily due to unconventional polices, current asset prices are not reflecting the actual fundamentals. It's time global central banks stopped such price distortions and halted stimulating the economies artificially for too long.

 

The following tables provide data on global bond yields, central bank interest rates and inflation rates:

Table 1: Global 10-year Bond Yields - how they changed between Dec2021 and Jun2022 >

Table 2: Global Interest Rates as of 30Jun2022 >

Table 3: Global Bond Yields, Interest Rates and Inflation Rates >

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P.S.: The following images are added after the above post is published, with information on global bonds datas as of 30Sep2022 > World GDP, inflation rates, interest rates and 10-year gov't bond yields > Images from Trading Economics >

 

   

References:

 

 Bond yields raw data as on 30Jun2022 >

 

Tweet 09Nov2020

 

Tweet 18Oct2020

 

Tweet 12Oct2020

Tweet 11Aug2020

 

Tweet 11Aug2020

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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. 

CFA Charter credentials  - CFA Member Profile

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He blogs at:

https://ramakrishnavadlamudi.blogspot.com/

https://www.scribd.com/vrk100

Twitter @vrk100

 

 

Global Bond Yields Surge - vrk100 - 05Mar2022

Global Bond Yields Surge

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(Please see updates for this blog: update 07Jul2022)

 

 

Global Bond Yields

Global bond yield have been on an upward trajectory in the past one year, against the backdrop of inflationary pressures exaggerated by supply chain bottlenecks following the outbreak of COVID-19 Pandemic.

For example, the US 10-year Treasury yield rose, year-to-date, by 23 basis points to 1.74 per cent (as on 04Mar2022); while those of the UK and Brazil surged by 26 and 144 basis points respectively (100 basis points equals one percentage point) in the same period (details in Table 1 below).

As discussed in my earlier blog, global central banks have not been raising interest rates, for fear of nipping the nascent economic recovery in the bud, even though inflation rates have surged globally lately. Consumer prices have gone up substantially both in the developed and emerging economies.

 Table 1: Global Bond Yields >

 

As at the start of 2022, there used to be three major countries with negative bond yields (10-year sovereign bond yield is generally considered as benchmark bond yield)--namely, Germany, the Netherlands and Switzerland. Now there is only one nation, that is, Switzerland, with negative bond yield among the major nations.

Russia's government bond yield spiked by 1147 basis points to 19.89 per cent in the past two months, following the Western economic sanctions  after Russia invaded Ukraine. To shore up its currency, rouble, Russia raised its benchmark interest rate from 9.5 to 20 per cent.

Russian rouble depreciated by 27.4 per cent against the US dollar since the beginning of this year. Conversely, the US dollar gained 37.7 per cent against the rouble. Despite raising interest rates by more than 10 per cent, rouble continues its slide against the dollar. It now quotes at 106.50 against the dollar from about 80 before the start of Russian invasion of Ukraine.

Global financial markets have been in turmoil following the invasion. Even before the invasion, surging inflationary expectations have roiled teh financial markets. The invasion exacerbated the market upheaval.

Commodity prices, including, crude oil, metals and agricultural commodities, have increased substantially in the past 10 days. This is going to benefit commodity exporting nations, like, Australia, Brazil and other South American nations, Saudi Arabia, Russia and others.

Major commodity importing nations, like, India and China, are at the receiving end of the commodity boom. Global supply chains have been disrupted heavily since 2o21, following the COVID-19 Pandemic lockdown and workers opting out of employment due to homecare needs, health issues and fear of the virus.

 

Global Interest Rates

Table 2 shows the changes in benchmark interest rates of major countries across the globe. Major central banks have been avoiding raising of interest rates even though inflation rates have been rising for more than a year.

But there are a few countries which have raised interest rates to control inflationary expectations. For instance, Brazil raised its benchmark rate by 150 basis points year-to-date. Bank of England raised its bank rate by 25 basis points; while China decreased its interest rate by 10 basis points.

Table 2: Global interest rates >

 

Globally there are only three nations, namely, Japan, Denmark and Switzerland that maintain negative interest rates officially. There is no change in the benchmark interest rates for more than a year in these nations.

Russia's central bank raised its interest rates from 9.50 to 20 per cent last month, to stem to depreciating rouble, while the rouble exchange rate remains oblivious to the hike in interest rate. In Economics 101, higher interest rates lead to stronger domestic currencies.

The US, India, the European Central Bank (ECB), Turkey and Australia have not raised their interest rates even though consumer prices have shot up in these countries.

(Blog continues below)

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Global Inflation Rates

Table 3 delineates inflation rates (consumer price inflation or CPI), 10-year bond yields and interest rates of major countries. The US inflation rate in January 2022 is 7.50 per cent, which is the highest since February 1982. The UK inflation rate is 5.50 per cent, the highest since Mar1992.

Table 3: Global bond yields, interest rates and inflation > 

Conclusion

The article explored how global interest rates and bond yields have changed in the past two months with surging inflation globally. With rising commodity prices and heightened global uncertainty after Russia invaded Ukraine, volatility in financial markets has increased. 

The CBOE VIX (volatility index) rose from 17 at the start of 2022 to 32 now, implying higher risks for the US stock prices.

The Federal Reserve, America's central bank, at the forthcoming March 16th meeting, is expected to raise the federal funds rate (or fed rate simply) by at least 25 basis points. Before Ukraine invasion, the Fed was expected to raise the fed rate by at least 50 basis points. But after the turmoil in financial markets, Western sanctions on Russia led by the US and Euro area nations and surging commodity prices, the global economic outlook seems to have changed. For the worse.

So, it is expected that the US Fed will take into account the downward projections in the US economic growth, heightened financial markets volatility and record-breaking rise in inflation rates.

Overall, my expectation is that the Fed may raise the fed rate by 25 basis points at the forthcoming March 15-16th meeting, provided other things remain the  same in the interim. Let us revisit how things pan out in the next 10 or 12 days.

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P.S. 1: Global bond yields were volatile in the past two weeks, with yields rising till February 24th, 2022 when Russia invaded Ukraine. For example, the US 10-year Treasury yield topped at 2.05 per cent in mid-February 2022 and was around 2.00 per cent on February 24th; but quickly slid to 1.74 per cent now. Due to higher global uncertainty, investors flocked to safe-haven assets, like, the US Treasury bonds, pushing up bond prices and lowering yields (bond yields move inversely to prices). 

This yo-yoing is also reflected in the fall of negative yielding debt and its rise post-Ukraine invasion. As per a graph shared on Twitter, the total negative yielding debt (as reflected in Bloomberg Barclays Global Aggregate Negative Yielding Debt Index) in the world plunged to USD 4 trillion in February 2022, but rose quickly to USD 7.20 trillion after Ukraine was invaded by Russia. (At the end of Dec2020, the total negative yield debt touched a peak of about USD 19 trillion --see graph below)

Total negative yielding debt used to be at USD 2 trillion in 2015.

P.S. 2: There used to be five countries (Denmark, Finland, Germany, the Netherlands and Switzerland) with negative 10-year bond yields at the end of November 2021 (see Table 1 of my earlier blog). As of now, there is only country (Germany) with negative 10-year yield.

References:

Tweet thread dated 22May2021 on global bond yields and interest rates

Tweet thread dated 03Apr2021

Why do investors pay interest rate to lend money to governments? (negative yield debt)

Tweet 20Jun2019 - negative yielding debt

TE global bond yields

TE global interest rates

TE global CPI inflation

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. 

CFA Charter credentials  - CFA Member Profile

CFA Badge

He blogs at:

https://ramakrishnavadlamudi.blogspot.com/

https://www.scribd.com/vrk100

Twitter @vrk100

Global Bond Yields and Interest Rates - vrk100 - 29Nov2021

Global Bond Yields and Interest Rates

Follow @vrk100

 

(Please see updates for this blog: update 07Jul2022 and update 05Mar2022)

 

Major central banks globally have been following ultra loose monetary policies, by keeping interest rates artificially lower even though inflationary pressures have been building up considerably since the beginning of 2021.

In normal times, central banks would have raised interest rates to keep inflationary expectations and rising inflation in check. But most of the major central banks, like, the US Federal Reserve, Bank of England, the European Central Bank, Reserve Bank of Australia and Reserve Bank of India, have kept their interest rates unchanged in 2021.

 

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These central bankers have been arguing that the current inflation is transitory, buoyed by broken global supply chain mechanism following the disruptions caused by the COVID-19 Pandemic. 

Let us see how the global bond yields and interest rates of major nations have changed in the past six months:

Table 1: Data as on 29Nov2021:

Table 2: Data as on 21May2021:

 

As can be observed from the above two tables, major central banks have not raised the interest rates in the past six to nine months except those of Brazil and Russia. Brazil has raised its benchmark interest rates from 3.5 per cent to 7.75 per cent and Russia from 5 per cent to 7.5 per cent to rein in runaway inflation. 

During this period, Denmark has further lowered its interest rate, which is already in the negative zone. But Turkey is an extraordinary case. It has reduced its interest rates from 19 per cent six months ago to 15 per cent now. Turkey's supreme leader Recep Tayyip Erdogan seems to be driving the monetary policy in reverse gear, by cutting down interest rates drastically even though inflation has gone up substantially and Turkish Lira has been falling precipitously. 

Other central banks (not in the above list) that raised interest rates are South Korea, South Africa, Poland, Hungary, Singapore, Pakistan and Mexico. 

Interestingly, there were only three nations--namely, Germany, the Netherlands and Switzerland (Table 2 above)--where the 10-year benchmark bond yields were negative in May2021. But as of today, there are five countries--namely, Germany, the Netherlands, Switzerland, Finland and Denmark (Table 1 above)--where bond yields are negative.

Though global bond yields have not changed in the past six months, they went up considerably during the first quarter of 2021 (that is, Jan-Mar 2021). The changes are captured in Table 3 below:

It would be interesting to see how inflation will move in the next two quarters given the ultra loose monetary policies of major central banks, rising inflation worldwide and the challenges posed by the spread of new Corona Virus Omicron variant.

 

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P.S.: On 16Dec2021, Bank of England raised its policy interest rate to 0.25 per cent from a record low of 0.1 per cent. Mexico central bank, Bank of Mexico, on 16Dec2021 raised its benchmark interest rate from 5.0 per cent to 5.5 per cent.

 

Data as on 31Dec2021 (image added on 15Jan2022) > 

Tables with data of Oct2020, Jan2021 and Apr2021 >

References:

My tweet thread dated 22May2021 on global bond yields and interest rates

My tweet thread dated 03Apr2021

TE global bond yields

TE global interest rates

Disclosure:  I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial 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. 

CFA Charter credentials  - CFA Member Profile

CFA Badge

 

He blogs at:

https://ramakrishnavadlamudi.blogspot.com/

https://www.scribd.com/vrk100

Twitter @vrk100