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.
Bond Yields Increasing, Along With Volatility
Yield on 10-year U.S. Treasury bonds
%
2.20
2.00
1.80
1.60
2.25%
December
January
February
March
April
May
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.
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