10 Year Bond Yields

[rb]

I would say it's bad. That's because there's only one scenario in which that's good. That is that the fed raises rates to counteract an overheating economy. In that overheating economy corporate earnings surprise on the upside to overcome the increased hurdle rate. I don't think the odd of this are great.

Then there is a plethora of other scenarios, all of them bad. So while I can't predict the future I'm going with higher rates not good.

[Packer16]

But what is going to drive rates higher?  The only thing that drives rates higher for longer is inflation.  What drives inflation? Shortages of either people or materials.  I do not see either & just more capital being created with little destroyed which would cause shortages.  The interesting thing is that although the 10-yr rate has risen the 20-yr rate has been flat.  So we have a flattening of the curve versus a shift upward which tells me that Fed policy is bucking what the market wants to do.

Packer

[TwoCitiesCapital]

But what is going to drive rates higher?  The only thing that drives rates higher for longer is inflation.  What drives inflation? Shortages of either people or materials.  I do not see either & just more capital being created with little destroyed which would cause shortages.  The interesting thing is that although the 10-yr rate has risen the 20-yr rate has been flat.  So we have a flattening of the curve versus a shift upward which tells me that Fed policy is bucking what the market wants to do.

Packer

I tend to agree with this. Demographics support lower rates than would be expected in a similar scenario for the ENTIRE developed world. Further, pensions are dramatically underfunded and have been waiting 10+ years for higher rates that EVERYONE expected to come - at this point, many of them are desperate and dump billions into the marketplace to buy duration the moment rates back up 50 basis points. These are literally the whales in the market place - it pays to pay attention to their motives.

With demographics supporting the move into fixed income, forced buyers like pension plans in the mix, and central banks just waiting to buy at the hint of the next downturn - it's hard for me to envision long-term rates (10-years and onwards) getting much above 3% before the next rally in yields starts - particularly IF/WHEN the next hint of economic weakness comes through. T

he bond bull market WILL end - I just have a hard time envisioning it's immediate demise in a global environment that reflects demographic demand, low inflation, and desperate buyers with A LOT of money (pensions and Central Banks).

I'd revise this theory if inflation were to consistently exceed 2-2.5%. At that point, pensions might delay duration binges a bit in anticipation of higher rates and Central Banks would likely have the confidence to continue hiking which might exceed the drag from any demographic demand. Until then, I'm still in the camp of rates will head lower and this is merely a bounce within the secular trend downward.

I have all the respect in the world for Gundlach, but he has been wrong before about the bottom being in for rates and I imagine he may be wrong again. Crazy how some of these fund managers ignore the motives\movements of their largest clients (pensions).

[John Hjorth]

Moving forward, I think the ECB and BOJ will be key to long bond yields.

It really has surprised me what the FED has been able to accomplish in the US in the past 15 months. The Fed has demonstrated over the past 15 months that a central bank can raise rates from crazy low levels with little impact on the overall economy; they just need the guts to do it :-). I think back to pre-Sept 2016 and for 8 years straight all everyone was talking about all day was what the Fed was going to do. Today they are way down on the list of topics (and still important).

The ECB and BOJ have to tighten at some point in time so when the next recession comes they have options. They have a window today to do so. IF they do start to shift their stance I think bonds on the long end could spike (with a quick move of 40 or 50 basis points) and this could certainly spook stock markets.

I think the number one risk to the stock market today is a rapid rise in 10 and 30 year bonds. But this will only happen if the ECB and BOJ shift and get much more aggressive with slowing bond purchases and hiking rates; may happen in 2H if global economies continue to show solid growth.

I'm the least of a macro person one can think of, however I'll try to pursue Vikings post here a bit, on a more specific level.

I have several times posted here on CoBF, that with regard to Europe, I think one need to see and understand the shades and nuances of the economic development in Europe/EU. It's not just "a mess" in general. That, however, does not imply that there aren't problems, because there are.

European Commision: Autumn 2017 Economic Forecast.

If you really try to work with that page by clicking around on the map way down on that particular page and read just parts of the data contained in the map [click on the country you need data for] and the documents attached for each country, there is actually a ton of information and data about the reasonable current European economic situation.

Some observations:

1. The Scandinavian countries are doing fairly well.
2. Several of the Eastern European countries actually have strong growth right now.
3. The economic situation has materially changed in Spain and Portugal to the better, compared to a couple of years ago - the pendulum is on its swing on the right trajectory.
4. Even Greece is in growth mode now.

Over the last two years or so, the picture has changed from being "South [in general] is a mess" to that we now have an axis NW-SE orientation through Europe as an indicator of weakness: UK, France & Italy.

No need here to elaborate on UK, I haven't studied the French situation either yet, and then we have Italy: Italy hasen't really fixed its banks yet, so they are [in general] not able to support a ramp up of growth by lending.

I speculate, that's the real problem here for ECB, and I speculate that is the direction ECB is looking nervously - trying not to push Italy back in the hole again. [Like contrary to FED looking at the here on CoBF well covered Detroit economic situation to set interest rates.]

[Cigarbutt]

Just thinking out loud and not taking a specific position on the role of the ECB.
The 2017 report is interesting and draws a realistic picture of the present situation. Thanks for the link and the observations.

Just re-read their 2006 and 2007 Economic Forecasts.

Definitions
Forecast: prediction based on objective facts (ideally) or experience or something else. (my bold)
Foresight: vision, or a horizon of expectations, based essentially on your internal farsightedness, prudence or general mental preparedness. (my bold)

I would venture to say that if macro is useful at all, it should rest (at least try to) on the latter definition.

With all due respect, I find that the ECB does not discount the possibility that what "it" thinks or does may not be relevant for the Markets in certain scenarios.

[John Hjorth]

... With all due respect, I find that the ECB does not discount the possibility that what "it" thinks or does may not be relevant for the Markets in certain scenarios.

I like this line of thinking, Cigarbutt, [ : - ) ]

So what we really are looking for is an independent observer of this game, that is very smart and possesses foresight [in your terminology]  and willing to engage in forecasting. [in the context, that we know that the smart persons with such properties don't really engage in such activity] [: - ) ]

Point taken with regard to ECB. It's actually important here. It's a decisionmaker's description & view on the situation.

[HJ]

But what is going to drive rates higher?  The only thing that drives rates higher for longer is inflation. 
Packer

This may have been an easy statement to make when main players in the treasury market are private entities, banks and insurance companies, foreign or domestic.  Today, half of the treasury market is owned by foreign central banks and Federal Reserve, whose motivations are driven by as much politics as economics.  This statement becomes more questionable.  Over the long term, it certainly remains true.  But that long term can be much longer than most people's investment horizon. 

[Viking]

Long bond yields are continuing higher. The question is not if yields continue to move higher; I think higher yields is understood and accepted by financial markets. The question is rather how fast they will rise and at what level will the stock market start to pay attention.

What is the real driver of higher yields? I do not think fears of inflation is the driver. Rather, I think there is finally a realization that central banks around the world are currently far too accomodative with policy. The economies in the US, Europe and Japan have reached a stage where central banks need to normalize policy. And financial markets and economies appear to be ok with higher rates. The Fed gets it and is normalizing policy quickly. I think the ECB is just starting to get it.

I am sure something very significant is happening in the bond market; just not sure how it all plays out. In late December of 2018 when we look back on the year I think this may be the surprise story of the year. The move in yields the past 16 months has been pretty dramatic. We will see what the next 11 months have in store. Very interesting :-)

                      Sept 27 2016.     Jan 1 2018.    Jan 31 2018
US 2 Year.         0.75                      1.92.           2.14
US 10 Year.       1.56                      2.46            2.72
US 30 Year       2.28.                      2.81.           2.95

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

[petec]

I am attaching a chart of 10 year treasury rate from 1790 onwards. Data from 1871 onwards is more reliable but this is the data we have.

1790 to 1870 rates are 5% to 7%
1870 to 1960 rates hovered around 3%
1960 to 2000 rates shot up from 5% to 15% and then back to 5%
2000 to 2017 rates kept dropping from 5% to 2%

When people talk about "Normal" they are primarily referring to the 1960 to 2000 period.

When people talk about "New Normal" they are primarily referring to the post 2000 period.

But what is normal, is really a matter of how far back you are looking.

If we consider rates from 1870 ("Old Normal"), then current rates are nothing unusual.

If we consider rates from 1790 ("Really Old Normal"), then current rates are indeed low but not exceptionally so.

Vinod

The US was (largely) on the gold standard from 1971. The idea of the gold standard was that your dollar maintained its purchasing power measured in gold. In the long run, productivity growth might be expected to be equal to or even greater than gold supply growth, so in theory you could expect the purchasing power of your dollar to hold or even rise. And that's exactly what happened - inflation was negative in cumulative terms from 1870 to 1913, for example, and was almost zero in cumulative terms from 1870 to 1939 despite the devaluation of the dollar vs. gold in the 1930s. (NB I pick the starting date of 1870 because that's the first date Schiller has data for on his downloadable CAPE spreadsheet, and I pick the dates 1913 and 1939 as the last "normal" dates before major wars, which are always inflationary. I realise the deflationary decade leading up to 1939 was not normal, but nor was the inflationary decade leading up to 1929, and under the gold standard inflation and deflation had to more or less even out over time.)

Inflation became a feature of life from 1939 onwards (a function of the 1930s devaluation, war, credit creation in the postwar boom, and guns 'n butter policies) putting so much pressure on the gold standard that the US finally gave up on it in 1971 (the alternative would probably have been another depression). So, since 1971 we have had purely paper money. That brings the risk of inflation - and in fact, inflation has become an explicit policy target.

My point is: that change in inflationary expectations should have a significant impact on nominal rates, so you can't compare today's rates to those pre-1970 and certainly not to those pre-1940. A 3% rate under the gold standard was more or less 3% real with a very small risk of loss. 3% today is 1% real if the Fed hits its target and carries a real risk of loss if the Fed loses control for a period.

P

[mattee2264]

  I think a lot of people assumed the impact of quantitative easing would be inflation. Well it was. But inflation in financial assets rather than real assets. Presumably there will come a point where wealth effects drive consumption (although I think a lot of the beneficiaries are the very rich who have a low marginal propensity to consume) and also a point where companies start believing returns are better from capital investment than financial investment. Also it is usual at this stage of the cycle for commodity prices and wage inflation to start to push up prices and that hasn't really been a feature. Although you would think that could change. And as was pointed out it is not the appearance of inflation but the anticipation of inflation that will set things off. I think a lot of actors out there are suffering from a money illusion believing in the death of inflation which makes sub 3% nominal bond yields and 4% stock earning yields (adding maybe 2% for autonomous growth) seem reasonable. But over any medium term holding period you would expect inflation to eventually eat into those returns.