Various media analysts, such as the WSJ o BusinessInsider, reveal that something unusual is happening with US interest rates, although, truth be told, there is certainly no shortage of reasons for the financial system to behave in a strange and unprecedented manner. To put this into context, it is worth remembering that when an economy – as is currently the case with the US economy – achieves figures close to full employment and inflation close to the coveted 2%, its yield curve steepens. This is a logical consequence of the improving economic outlook, as in a scenario where a wealth of good business opportunities begins to emerge, it is normal for investors to demand higher returns in exchange for tying up their money in the long term, and lower returns on short-term maturities. The graphical result is a steeper slope in that currency’s yield curve, as has been seen countless times throughout history.
Well, what is currently happening to the US yield curve is quite the opposite, as you can see from the chart below. The spread between 2-year and 10-year yields is narrowing despite the undeniable improvement in unemployment and inflation figures. And this has been the case ever since the Fed began taping the money tap at the end of 2013, with the spread now reaching its lowest levels (the flattest yield curve) since the start of the ‘new normal’ era, that is, 2007.
Are the US economic figures not accurate? Is the slowdown in job creation we saw last week a prelude to another devastating recession in the US? That’s not the case. We’ll find the explanation if we broaden our perspective and analyse what’s happening globally with interest rates and yield curves. The situation regarding global debt is so chaotic that the central banks of developed economies – with the exception of the Fed – are driving interest rates into negative territory on a massive scale for their domestic bond issues. And this is forcing investors to seek positive returns wherever they can be found, thereby driving down the yields on most assets (as we had already pointed out here). Naturally, given the lack of returns in Europe and Japan, investors are looking to yields in emerging markets (which they are also driving down with their purchases) but, above all, to US Treasury yields. Due to this artificially imported global demand, the yield curve is flattening rather than steepening, despite the improvement in US macroeconomic figures.
The fact is that the actions taken by the European and Japanese central banks – to prevent the collapse of their debt and, consequently, their economies – in recent years have devastated yields across half the globe. Take a look at the chart below to see the enormous proportion of fixed-income assets in negative territory that the developed world now holds. In some cases, yields have entered negative territory due to the financial repression imposed by their central banks, whilst in others it is due to a desperate ‘flight to quality’ by investors who prioritise solvency and are willing to sacrifice returns entirely. This financial repression is turning the fixed-income market into a looming crisis that, for the time being, only a few of us are trying to avert:
To summarise and returning to the US yield curve, it is becoming distorted in a way that runs counter to what is set out in all economics textbooks. It is flattening out in the midst of an economic recovery because it is being driven more by the negative interest rates intended to counteract recession and deflation in other developed economies than by falling unemployment and rising inflation in the US. And what is even more surreal is that, as soon as the Fed’s rates begin to rise in line with the improvement in US growth and inflation, the spread with the rest of the world’s sub-zero rates will widen. Consequently, the greater the interest from international investors, the greater the downward pressure on yields and, therefore, the greater the flattening of the US yield curve. In other words, in the future we may see such a distortion that we end up with an inverted yield curve in the midst of a US economic recovery.
The world’s been turned upside down, yet again. And the fact is that the monetary policies currently being pursued for the past 3 years are already having some almost dystopian side effects, in the face of which investors must be very, very well advised. In other words, most conservatives They’ll end up in the ditches, unfortunately.
Source: BusinessInsider.com y Deutsche Bank