Best Value For Your Money from RamaKrishnaVadlamudi: negative interest rates

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Saturday, 30 December 2023

Global Bond Yields Fall Sharply - vrk100 - 30Dec2023

Global Bond Yields Fall Sharply

(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.)

During its meeting on 01Nov2023, the Federal Open Market Committee (FOMC) of the US Federal Reserve decided to hold its benchmark rate, the US Federal Funds rate, unchanged.

The financial markets considered the Fed decision as 'dovish' resulting in a big rally in bond prices, not only in the US but among major developed nations.

From 4.90 percent at the end of October 2023, the US 10-year Treasury yield fell to 3.87 percent by the end of December 2023, reversing the losses for bond investors (bond prices move inversely to bond yields, that is, when bond prices rise, bond yields fall and vice versa).

Earlier on 23Oct2023, the 10-year US Treasury yield touched a high of 5 percent, which was the highest in 16 years.

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The following four tables will describe how bond yields, benchmark interest rates and inflation rates moved between end-30Sep2023 and end-31Dec2023, that is, during the last quarter of 2023.

Table 1: Real interest rates:

Table 1 above delineates real interest rates, consumer price inflation (CPI), benchmark interest rates and 10-year bond yields of major nations.

Compared to nine months ago, more major nations enjoy positive real interest rates now, which are good for savers.

The real interest rate (benchmark policy rate minus CPI inflation) is 2.27 percent for the US, 1.35 percent for the UK, 7.07 percent for Brazil and so on.

Countries, like, Japan, Australia and Turkey have negative real interest rates as shown in table 1 above. With a negative real interest rate of 19.5 percent, Turkey is a bizarre case.

Turkey was reducing, during the latter part of 2021 and early part of 2022, its interest rates even as inflation was raging. Turkey's supreme leader Recep Tayyip Erdogan was driving the monetary policy in reverse gear, by cutting down interest rates drastically even though inflation had gone up substantially and Turkish Lira had been falling precipitously.

However, after presidential elections in Turkey in May 2023, Turkey's central bank started raising interest rates to anchor inflationary expectations. As per latest available numbers, Turkey's official CPI inflation is 62 percent.

Table 2: CPI Inflation:

During the fourth quarter of 2023, consumer price inflation (CPI inflation) rates across major nations have fallen between 460 basis points and 7 basis points (100 basis points equal one percentage point).

But CPI inflation rates in Turkey, Russia and the Netherlands have risen between 140 basis points and 304 basis points.

The main reason for the sharp decline in inflation rates in the US and Europe is mainly due to fall in commodity prices, like, crude oil, natural gas, coal, gasoline, wheat, cheese and milk.

Interestingly, Japan's CPI inflation at 2.80 percent is higher than Euro area's inflation of 2.40 percent. For longer than a few decades, Japan suffered deflation and in recent years, it is experiencing a little bit of inflation.

Table 3: 10-year bond yields:

For all the countries shown in table 3 above, 10-year bond yields have fallen, especially in the past two months following the FOMC meet on 01Nov2023.

No major central bank has decreased interest rate during Oct-Dec2023 quarter (see table 4 below). Despite not decreasing the benchmark interest rates, the 10-year yields of the major countries have fallen sharply during the fourth quarter.

For example, the 10-year bond yield in the UK was down 92 basis points; in Brazil, it was down 144 basis points and in Italy it was down 112 basis points -- even though there was no change in their benchmark policy interest rates (see table 4 below).

Why is this so? In general, bond yields move in line with changes in interest rates by central banks; in turn, raising / falling inflationary expectations influence the central banks to increase / decrease the interest rates.

During the fourth quarter, the stance of US Federal Reserve, the central bank of the US, has given the hope for markets that the Fed would be forced to cut interest rates next year.

The market expectations and speculation that the Fed would cut interest rates in 2024 has fueled a big rally in bond prices, with the US 10-year Treasury yield falling by 71 basis points in the fourth quarter -- even though no central bank actually cut interest rates.

However, central banks of Russia, Turkey and Australia raised their benchmark interest rates during Oct-Dec2023 quarter (see table 4 below).

Table 4: Central Bank benchmark rates:

Argentina:

Before we close, it is worth mentioning what is happening in Argentina. Since 2012, Argentina has been experiencing anemic growth in GDP (gross domestic product or national income). It has also been experiencing runaway inflation in the past 10 years.

The current inflation rate is 161 percent there and unemployment rate is 5.7 percent. Argentine central bank's benchmark policy rate is 100 percent.

During second week of Dec2023, Argentina's new government led by Javier Milei devalued its currency peso by more than 50 percent. The new president Milei openly says he will overhaul the government and economy by bringing in radical and unconventional policies.

Before the devaluation announcement in second week of Dec2023, Argentine peso was quoting at around 365 pesos to the US dollar. After devaluation, it is currently quoting at 808 pesos.

The Argentine government says it has no money and argues these radical measures, like, currency devaluation, are painful in short term but would bring long term benefits.

Argentina is South America's second largest economy, but it has a long history of political and economic instability. For long, it has been plagued by military coups and vagaries populist governments.

It has a history of foreign debt default also.

According to Wikipedia, Argentina has defaulted on its debt nine times since 1816 - the latest international debt defaults are in 2001, 2014 and 2020.

Strangely, Argentina was one of the world's wealthiest countries at the beginning of 20th century. It wouldn't be an exaggeration to say it was better than the US in those days on several metrics.

It has rich natural resources and a well-educated workforce. It is world's eighth largest country by area with 1.8 percent of world's landmass.

That such a country should face an economic crisis repeatedly is quite odd. There seems to be no end to economic chaos in Argentina. Let us see whether the new government will bring the economic ship to stability.

Every country needs to learn a lot from Argentina's economic and political failures.

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Read more:

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Global market data 31Dec2023

India Per Capita Income in Dollars

RBI Annual Report and HBIE - Data Tables

India Foreign Exchanges Reserves Comfortable

Analysis of Small Savings Schemes and Interest Rates

Is De-Dollarization Real?

India Debuts 50-year Sovereign Bond

India: Prospects and Challenges

India Public Debt and Floating Rate Bonds

India Equity ETFs Worth Considering

JP Morgan Guide to Markets Sep2023

Mutual Fund Asset Class Returns 30Sep2023

Buyback Offers and Weblinks

Negative Impact of Debt Mutual Fund Tax Changes

Weblinks and Investing

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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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Saturday, 30 September 2023

Divergence in Volatile Global Bond Yields - vrk100 - 30Sep2023

Divergence in Volatile Global Bond Yields

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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.

(article continues below)

-------------------

Related Blogs on Bond Yields

Scourge of Negative Real Interest Rates Continues

Global Bond Yields, Negative Real Rates and Soft Landing

Global Bond Yields and Asset Prices 07Jul2022

Global Bond Yields Surge 05Mar2022

Global Bond Yields and Interest Rates 29Nov2021

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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