Thank you for subscribing to my posts. If you’re not yet a paying supporter, please consider becoming one. That’ll allow you to DM me with questions and comments. Your contribution will help cover the cost of the data I use in my posts, which I fund out of my own pocket. Thanks so much for your support and feedback!
Much of the commentary on the rise in long-term government bond yields, which I’ve been banging on about for the past year, has lost itself in technicalities. One debate is on whether we’re just seeing a normalization in yields back to levels we’ve seen in the past. Another is about whether the rise in yields is simply about markets pricing more hawkish central banks, while risk or term premia remain contained. All this stuff has the whiff of “the frog in boiling water.” In some places, what’s going on with longer-term yields is starting to feel like a crisis, notably in France and Italy.
The “whataboutism” on debt misses all the alarm bells going off at high frequency. We’ve had a series of mini blow-ups this year, starting in January with the sharp spike in Japan’s long-term yields after Prime Minister Takaichi said “excessive” austerity is for the birds. The steepening of the US yield curve after the dovish Fed meeting at the end of July - coupled with a sharp drop in the Dollar and spike in precious metals after the surprise buyback announcement by the Treasury - is another example. Yesterday’s spike in long-term yields for France and Italy - from already high levels - is the latest incident. Over the past year, the global bond sell-off has been a shape-shifter, hitting first here and then there. But in recent months it’s zeroed in on these two places as the most vulnerable. They’re now on the cusp of full-blown crisis.
The charts above show government bond yields for the US (top left), Germany (top middle), Japan (top right), the UK (bottom left), Italy (bottom middle) and France (bottom right). The black line in each chart is the 2-year yield, which captures market expectations for monetary policy. The blue line is the 10-year yield, while the orange and red lines are the 10y10y and 10y20y forward yields, respectively, which I back out from 10-, 20- and 30-year yields. The advantage to 10y10y over a 20-year yield is that it strips out the first 10-year yield portion, so 10y10y forward is less dependent on near-term monetary policy expectations. The same is true for 10y20y forward.
A couple of points are worth making. First, long-term yields are rising everywhere, pushed up by markets pricing more hawkish central banks for longer. If markets think geopolitical instability means higher oil prices for longer, they price higher long-term yields, even when those strip out what’s going on at the front end of the yield curve. Second, the rise in long-term yields isn’t normalization. The 10y10y forward yield in practically every country is now well above it’s previous high going back to 2006. The only exceptions are Germany, which still has some safe haven status, and Italy, which was in crisis fifteen years ago. Third, yesterday saw 10y10y forward yields for France and Italy rise eleven basis points. Those are multi-sigma moves from already elevated levels. For perspective, 10y10y forward yields for the US and UK yesterday rose five basis points and neither place can be accused of being fiscally prudish.
There’s obviously the question why markets have zeroed in on France and Italy. One reason is that the ECB’s hands are tied because sovereign spreads over Germany have stayed tight. This means there’s no argument to be made that rising yields constitute “financial fragmentation,” which is the word salad the ECB invented to justify what are really just yield caps that subsidize high-debt countries in the Euro zone. Spreads will have to widen out a lot more before the ECB can step in, which seems to be where we are heading. Markets are exploiting this blind spot in the ECB’s toolkit.
There’s a place for academic debates on what to read into rising long-term yields, but not when this is at the expense of all kinds of short-term signals that are worrying. A crisis always starts in the most vulnerable places and spreads from there. That’s what’s happening now.