This year the US, UK and German bond markets have moved together. Whatever the news, rates have followed similar trends and patterns. It is true US rates have stayed the highest of the three, and German rates by far the lowest.
In each market rates fell from their highs on 1 January to reach new lows in early April. After the UK referendum the yields fell away again, reaching dramatically low levels in July and August. More recently the yields have risen steeply from the summer levels.
German 30-year rates began the year at 1.5 per cent, fell to a low of 0.3 per cent, and are now back up at 0.9 per cent. UK 30-year state borrowing costs were 2.7 per cent on 1 January, reached a low of just over 1.2 per cent in August and are now a little over 2 per cent.
The US 30-year bond started 2016 with a yield of 3 per cent. This fell to under 1.4 per cent, and is now back around 3 per cent. The 10-year rates traced a similar pattern, with the German rate now at 0.3 per cent, the UK rate at 1.45 per cent and the US rate at 2.3 per cent.
Because interest rates are so low, they are very volatile if you measure the change as a percentage of the starting rate. The background to the low rates is an era of quantitative easing (QE), with the authorities in each of the three jurisdictions creating money to buy bonds to drive up the bond price and thus drive down the percentage income the holder enjoys on the bond at market prices.
Each Central Bank has kept short term rates very low, with the UK actually cutting rates further at the end of July. The US this year has not continued with more QE, though the ECB and the Bank of England have. As a result the low rates at the beginning of the year have fallen away more, and are still lower after the recent bond market sell off than in January.
What should we make of this? Investors have become very reliant on benign central bank activity to keep rates low and to support markets. There is daily comment on what the Fed or the ECB might do next, as bond dealers nervously watch out for any sign that the monetary authorities might end their efforts to keep markets high.
The Japanese authorities who have been running very accommodative polices for years upset the markets early in 2016 when they announced a negative short-term interest rate and implied they wanted higher long-term yields. Since then they have sought to confirm their wish to keep ten-year rates around zero with sufficient intervention to do so.
The European authorities keep issuing reassurance that they will carry on with bond buying, even though they are exhausting the bonds they are allowed to buy under their self-imposed limits. The UK authorities promised more action to come when they announced their latest bond buying programme, but have subsequently cooled their language in the light of strong economy figures.
It looks as if the US and the UK are detaching themselves from the large stimulus policies of the European and Japanese Banks. The Fed’s view is the US economy is strong enough to warrant a rate rise soon and maybe more rises next year. There is no question of any more QE.
The Bank of England is less clear about its intentions, but if UK growth remains good it is difficult to see why they would want to buy any more bonds once the current programme is complete. Meanwhile it looks as if the Europeans and the Japanese will be experiencing more bond-buying for the foreseeable future, with the aim of keeping short rates around zero.
All this suggests a stronger dollar and a weaker yen and Euro. People tend to switch into higher-yielding currencies out of low or no income currencies, if those higher-yielding currencies are backed by stable and growing economies. It also implies very low-yielding bonds in Japan and the Euro area given the potential official support. Given the low or non-existent income available they are not attractive looking long-term investments.
What the main central banks have done is persuade people to buy government bonds for possible capital gains rather than for the income they produce. As the last few weeks have shown, it is very easy to lose money on low-yielding bonds when the market mood changes. Even the fact that the ECB and the Bank of Japan are going to carry on buying was insufficient to sustain their bond prices. We have been warning against holding any negative yielding bonds, and prefer shares to bonds where portfolio rules allow.
John Redwood is Charles Stanley’s chief global economist.