Irrational Exuberance in Gilt market

August 12th, 2016 6:47 am | by John Jansen |

Via WSJ:

By James Mackintosh
Updated Aug. 11, 2016 4:27 p.m. ET

Britain has taken over from Japan as the world’s wildest bond market, raising new questions about the distortions being caused by central banks.

The soaring price (and so plunging yield) of the 30-year gilt means it has now returned the same 31% over the past 12 months as the Japanese 30-year note, even as some of the excess in long-dated Japanese bonds falls away.

The race into gilts partly anticipated and was accelerated by the Bank of England’s resumption of bond purchases this week, part of a package of monetary easing designed to offset damage to the economy from June’s Brexit vote.

Lower gilt yields are in turn contributing to demand for global bonds, helping keep U.S. Treasury yields depressed even as other market moves suggest a revival of hopes for growth and inflation.

This again raises a long-running problem for investors. Should they regard low yields as a sign of how grim a future is in store for the world economy?

Or are central banks distorting the signal so much through bond purchases that yields no longer carry much information about the economy?

The rally in gilts has been extraordinary, with the yield on the U.K.’s longest-dated bond, the 2068 maturity, almost halving from 2% on the day of the referendum to 1.06% on Thursday.

The price of the bond is up 53% this year, the sort of gains usually produced by risky stocks, not rock-solid government paper. (Its performance roughly equals the gains of sixth-best stock in the S&P 500, Range Resources.)

“This is not normal,” said Mike Amey, who manages sterling bond portfolios for fund manager Pimco. He called the speed of the move “eye-popping.”

The 18.8% two-month return on the 30-year gilt has been bettered only during the rescue of hedge fund Long-Term Capital Management in 1998, according to Thomson Reuters data since the late 1980s.

The result has been that falling gilt yields have taken over from Japanese government bonds in exerting downward pressure on Treasurys and other global bond markets.

The 10-year Treasury yields 1.57% and is little changed over the past month, in spite of strong jobs market data and a sharp rise in inflation expectations derived from inflation-linked bonds.

Equity markets have been showing signs of renewed faith in U.S. growth and inflation. Cyclical sectors, those most exposed to the economy, have risen a little, while the defensives best able to withstand a recession have fallen back.

The utilities, consumer-staples and telecom stocks, whose reliable dividends were in demand, were three of this year’s four best-performing S&P 500 sectors until a month ago, but have all fallen since.

Chris Watling, founder of consultancy Longview Economics, draws a parallel with the experience of the 2000s. Back then, the Federal Reserve was puzzled that longer-dated yields stubbornly refused to rise as it jacked up interest rates—something Fed Chairman Alan Greenspan called a “conundrum.”

“It’s like the bond yield conundrum squared,” Mr. Watling said.

One explanation for the conundrum advanced by Ben Bernanke, Mr. Greenspan’s successor, was that a global savings glut was holding down bond yields.

This time it is a glut of money printing, as the Bank of England joins the Bank of Japan and European Central Bank in buying bonds.

In 2006, it turned out that the refusal of the long bond yield to budge even as interest rates rose above it carried useful information: Bond buyers were correctly anticipating bad times ahead.

Investors need to decide whether something similar could be under way now.

If British, Japanese and German yields reflect weak growth ahead in those countries, America might suffer too.

On the other hand, if bond yields are low only because of government manipulation, then the message from the bond market might be meaningless.

Francesco Garzarelli, co-head of European macro research at Goldman Sachs, argues that gilt yields are falling in part because bond investors are holding out to sell to the BOE at a higher price in future.

“The Treasury market’s trying to reflect some of this cyclical recovery but it’s just being swamped by global factors,” he said. “The U.S. is trying to pull global rates up, but Japan and the U.K. together are pulling down with a much larger force.”

In other words, Treasurys may be low thanks to policies made in the BOE’s Threadneedle Street headquarters—not because those tentatively betting on an economic rebound are wrong.

Write to James Mackintosh at

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