| Labels: Mass injuries continue to mar otherwise spectacular NBA play offs katrina
If you happen to trade bonds for a living, it is entirely understandable if you are feeling a little anxious these days.
Prices for United States Treasuries, German bunds and most other securities on the multitrillion dollar global bond market have been exceptionally volatile in the last couple of months. In this environment, someone who buys and sells them for a living could lose a fortune by taking an ill-timed bathroom break.
But what happens in bonds matters for the rest of us, too. Bond prices translate into the price to borrow money for practically every family and business on earth, which, in turn, determines savings and investment patterns. In the latest bout of volatility, long-term interest rates in the United States have climbed by almost 0.4 percentage points. Since the interest rate is in an inverse relationship to a bond’s price, the value of bond investors’ portfolios has taken a hit.
And that helps explain why there has been so much hand-wringing over the ups and downs of the market in the last few weeks, as my colleague Peter Eavis has reported.
Bankers are warning that tighter regulations may preclude them from playing their traditional role of stepping in to buffer the ups and downs of markets. Regulators worry that asset managers are engaging in herd behavior that will fuel an unnecessary roller coaster in markets. And there is plenty of worry out there that years of central bank interventionism have dulled the proper functioning of markets.
These arguments all have merit, and they aren’t mutually exclusive. And when you look closely at what has been happening with bond prices, what it says about the economy is pretty much benign. What it says about how some of the markets at the core of the global financial system are working is far scarier.
So first, what does the shift mean for the economy?
Ten-year U.S. Treasury bonds were yielding 2.26 percent Wednesday, up from 1.87 percent in late March; those higher rates have also rippled through to higher mortgage rates and corporate borrowing costs. Some international long-term interest rates, particularly in Germany, have climbed steeply. Some economists are even raising the possibility that a generation-long shift toward ever-lower global interest rates might have finally run its course.
Not so fast. Interest rates are still extraordinarily low by any historical standard and still below where they were in the fall of 2014. Viewed in a longer time horizon, it looks as if the bond boom of late 2014 and the start of 2015 went too far and is now partly reversing, not that some new trend of higher rates is taking hold.
The factors that fueled those low rates to begin with — very low global inflation, vast pools of global savings looking for a place to be parked, central banks trying to use easy-money policies to restore growth — have changed after all.
You don’t have to believe there is an epochal shift going on, only modest changes in the last couple of months that can justify the move.
It looks as if higher rates are coming. The Federal Reserve appears relatively committed to its plans to raise short-term interest rates sometime this year. Oil prices have risen after falling to recent lows over the winter, so inflation should be a bit higher than it had seemed in February. And the dollar has weakened on currency markets, which also signals higher inflation.
Those all point to higher bond yields, and that’s exactly what we’ve gotten, with no major mystery.
What is more of a mystery is why we’ve seen such abrupt turns in a market that historically has been slow-moving and not prone to overreactions.
Usually it’s the stock market that is always rising and falling for reasons that are hard to explain (or justify). The bond market, dominated by sophisticated, grown-up institutions like pensions and sovereign wealth funds as opposed to individual investors, has traditionally seemed less prone to irrational jitters.
In other words, there are perfectly plausible, fundamental reasons the 10-year Treasury yield should be 2.26 percent right now. But reasons it should have risen by half a percentage point since the start of February, with many jaw-dropping days in between? They are hard to fathom when nothing terribly dramatic about the economy or policy outlook has changed since then.
And that’s where we get to those explanations mentioned above involving the technical details of the bond market: things like banks being restricted from trading operations by new regulations, and asset managers crowding in and out of trades.
We’re in a world where the supply of bonds is relatively fixed. It has always been true that governments don’t quickly adjust their deficit spending plans based on a move in rates. But in a normal state of affairs when prices rise, private bondholders are more willing to sell, helping restrain the size of swings.
But now global central banks, having bought trillions of dollars’ worth of bonds in executing their quantitative easing programs, are not inclined to exploit price moves opportunistically. Rather, they are moving glacially, based on economic fundamentals, and with lots of advance communication on their intentions.
Count other institutions that hold bonds as insurance against economic catastrophe — not because they are hoping for meaningful return — and the number of players in the market responding to prices in an economically rational way is small.
This is a long way of explaining the common term of art in markets: There is less liquidity than there once was.
One result is big swings based on small pieces of information, as the buffers that would normally sell into price increases and buy into price drops are nowhere to be found.
And there’s not much reason to think that the forces driving this — the expansive role of central banks in the market, the structures of banks and asset managers and so on — are going to change anytime soon.
In other words, bond traders may just want to get used to postponing those perilous bathroom breaks.