Why Greenspan's Bond Conundrum Looks Like the New Normal

  • Global savings limit Treasury yield rise: Oxford Economics
  • Technical forces may account for depressed long-dated yields

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More than a decade after markets first encountered the notion that bonds can resist the pull of benchmark interest rates, investors are facing a rerun of the perplexing conundrum.

The yield on benchmark 10-year U.S. Treasuries has tumbled from its post-election high even as equity markets dance to a bullish beat -- sparking fears that the global market rally could be on thin ice if the bearish growth prognostications implied by government bonds come to pass.

But markets shouldn’t overthink the conflicting messages being sent by bonds and stocks, according to Oxford Economics Ltd.’s Gaurav Saroliya. He argues that the ability of Treasuries to signal what’s coming up for the wider economy is overrated thanks to a glut of excess savings and more coordinated business cycles that have helped curb the post-U.S. election advance in yields.

In doing so, Saroliya is pushing back against traditional models for bond yields, which fuse expectations for domestic interest rates, inflation and nominal output over the long run. He’s also echoing a growing chorus of researchers who argue that sweeping changes in the world’s financial markets will help support Treasury prices for years to come and even in the face of rising inflation.

“Global forces look set to limit rises in long-end bond yields even for markets where there may be local reflationary impulses,” Saroliya wrote in a client note last week. “A trend rise in long-end yields requires a pick-up in global trend inflation, which, our research shows, isn’t imminent.”

In other words, long-dated U.S. Treasuries are stuck in a rut thanks in large part to a glut of global savings and depressed core price pressures across the euro-area and Japan, according to the London-based analyst, who warned in mid-March that such global forces would help spur a decline in the 10-year Treasury note from 2.6 percent by as much as 100 basis points. Since then the benchmark bond has unwound about half its post-election advance to yield 2.33 percent.

Data from 11 markets shows the global pool of sovereign debt moving to a similar beat, sharing 67 percent of variation in yields, Saroliya’s research shows, deploying a study known as principal component analysis. In other words, global bond markets are far more concentrated than in the past -- and are influencing each other more than ever.

“Our analysis suggests that intuitive anchors of long-end nominal yields, such as nominal GDP growth, are alone unlikely to perform well in the current regime of large cross-border capital flows and structural forces such as the global savings glut,” he says.

That echoes the conundrum that faced markets back in 2005, when former Fed Chairman Alan Greenspan noted swelling current account surpluses in China and the Gulf were driving a decline in long-term yields and defying a series of policy rate hikes.

Oxford Economics Ltd

Saroliya’s study is the latest to highlight the weakening link between short-term policy rates and long-end yields thanks to an increase in correlations across developed markets -- a challenge that Greenspan’s successor, former Fed Chair Ben Bernanke, has cited for the U.S. central bank as it smooths the business cycle through anchoring borrowing costs.

A Bank for International Settlements report last year, for example, found that a 100 basis point rise in long-dated Treasury yields is associated with a 79 basis point increase in similar-duration yields in other advanced economies, as globalization has pushed business and investment trends to move in lockstep. Strategists at Societe Generale SA, meanwhile, reckon swelling current account surpluses in the euro-area and East Asia will cap sovereign bond yields this year.

Investors fearful of economic signals implied by low long-dated bond yields may find additional comfort from the BIS, citing the buying behavior of pension and insurance funds who need to buy more assets to offset falling yields that swell their funding shortfalls.

"Very low yields on long-term government bonds may not necessarily signal prolonged future economic stagnation and deflation but instead reflect efforts by institutional investors to limit risk," Hyun Song Shin, head of research at the BIS, concluded in a speech in March.

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