As we arrive at Christmas Eve and the end of my blogging year we see that the main economic themes of 2024 are still in play. Let me start with one that as we came into the year looked if we use modern language that it was like, over.
Since September, the ten-year Treasury bond yield – what it costs the US government to borrow money for a decade – has jumped from 3.6pc to 4.6pc, even though the Fed’s benchmark rate has been falling. ( @LiamHalligan )
The quote highlights the first issue which is that there has been a major shift in the yield curve. As someone who has been involved in bond markets for several decades this raises a wry smile as the media took an interest for a while ( remember the obsession with 2s/10s) but has mostly been looking elsewhere as we have seen a big shift.Actually this brings me to another area where we see media silence and that is the reality that this shift has been awful for the balance sheets of the various central banks. If you load up with bonds and longer yields surge then it looks awful and of course they have trillions of them. Their existing position was poor and now it looks awful. The US Federal Reserve even has the cheek to call its losses “deferred assets” and the ECB tries to look the other way entirely. Here is the German Bundesbank.
To offset the loss recorded in the 2022 annual accounts, a withdrawal of €1 billion was made from the provisions for general risks. To offset the loss for 2023, the remaining
€19.2 billion in provisions for general risks will be released in full.
Remember that is only for the interest-rate risk representing buying bonds at negative yields and paying the ECB Deposit Rate so the interest-rate cuts will have helped. But the capital losses are ignored. Along the way we can look at QT balance sheet reductions via the Alan Parsons Project.
Can’t sleep alone at night
I just can’t seem to get it right
Damned if I do
And I’m damned if I don’t but I love you
I said I’m damned if I do
And I’m damned if I don’t cause I love you
Reductions so far have been expensive as they bought high and effectively sell low ( literally in the case of the Bank of England). But with bond yields rising any capitalised losses look cheap relative to the mark to market position. So we have a situation where Bank of England sales took large losses but all of them now look good relative to where we now stand.
Those who follow my work will now that I warned about the problems that all the QE bond buying would create and we are now in that zone. The Bank of England suggested that 0.5% and 1% were significant levels but ended up with egg on its face as it raised to 5.25%. Let me now look ahead as they need a way out of this and the two obvious ones are some sort of off balance sheet vehicle and substantial cuts in interest-rates. The issue with an off balance sheet vehicle is that the money supply will remain inflated and the latter is how do they justify it? Of course the sustained rises in interest-rates may break something or they may look for a crisis.
Let me end this section by reminding us of another failure which has been central bank Forward Guidance ( on future interest-rates).
So with the official interest-rate in the range 5.25% to 5.5% they signaled future interest-rate cuts approaching 2%.
That was my summary of the Federal Reserve December 2023 announcement and it lit up bond markets.
2s, the shunned tenor, was the BIG winner today. outperformed
5s by 5 bps
10s by 11 bps
30s by 16 bps ( @fullcarry)
This time last year the US ten-year yield fell as low as 3.78% whereas as I type this it is 4.6%. So some 0.82% higher whereas the cut this December means that interest-rates have so far fallen 1%. A large yield curve change and as I pointed out earlier awful for the central banks.
Japanese Yen
There is something awfully familiar about this from ForexLive.com.
Japan Finance Minister Kato with some typical verbal intervention efforts:
- Says it is important for currencies to move in a stable manner reflecting fundamentals
- Recently seeing one-sided, sharp FX moves
- Concerned about recent FX moves
- Will continue to coordinate with overseas authorities on forex policies
- Will take appropriate action against excessive moves
Ah “one-sided!” So that is how he wants the fall in the Japanese Yen to 157 versus the US Dollar to be viewed. The “coordinate” bit is so wide of the mark it is even funny. Let me illustrate with this from Reuters earlier today.
Bank of Japan policymakers agreed in October to keep raising interest rates if the economy moves in line with their forecast, but some stressed the need for caution on uncertainty over U.S. economic policy, minutes of the meeting showed on Tuesday.
There was more in that vein.
The BOJ left interest rates steady at 0.25% at the October meeting but projected inflation to move around its 2% target in the coming years, signalling that it was on track to hike borrowing costs in the near-term horizon.
Now we have “on track” a phrase which acquired a new meaning during the Greek depression. For younger readers according to the IMF and Euro area authorities the Greek economy was on track for recovery as it collapsed into a severe depression. Indeed using that new definition the Bank of Japan was on track to raise interest-rates this month, which in the real world it did not. There are only so many times you can cry wolf and the Bank of Japan has exhausted them. For all the open mouth operations about higher interest-rates it has only raised them to 0.25%. On the other side of the coin the number and size of expected US interest-rate cuts has been falling so the Japanese Yen has been hit by both trends.
Putting it another way I warned about this on the 1st of October 2023.
As you can see the Bank of Japan ignores marked to market losses. If I owned so many JGBs I might be tempted to do that as well but of course I would go straight to jail. Even under current policy they have large losses at a benchmark yield of 0.75%. Imagine what they would be if Yield Curve Control stopped and interest-rates rose and you quickly come to the conclusion that fears over its balance sheet have been a factor on the Bank of Japan not raising interest-rates.
The Bank of Japan is worried about its balance sheet and even with it moving at a pace that would embarrass a snail things have got worse. The ten-year yield is now 1.06% giving it a taste of what might happen if it raised rates further. If it keeps the official rate down it can claim profits based on relative interest-rates and turn a Nelsonian style blind eye to capital losses.
Comment
As you can see this is the year that the central banks lost control of interest-rates. Or if you prefer the mythical bond vigilantes came back a partied. The reality is that several things happened at once. Even the most avid central banking fans have to admit to a host of central banking Forward Guidance failures. Their ant-inflation credibility was torpedoed by the “Transitory” claims. They bought trillions of bonds at the top and now own them at the bottom ( so far). Or putting it another way the yield curve shifted against them. In rather an irony their own QT balance sheet reductions added to this.
They thought their interest-rate cuts would cover this. But so far it is not working.
Let me wish you all a very Merry Christmas and I will be back in the New Year,