Why have yields on US Treasuries been so much above other nations?
I am not referring to the recent spurt on the 10 year towards 4.98%; Rather, I am referencing the generally higher yield on US Treasuries versus other westernized nations (UK, Canada, Germany, Japan).
In the past, we have seen this spread occurring in periods of elevated US risk:
click for larger graph
Source: Bloomberg
>
Justin Lahart notes the impact of the dollar on this process:
"U.S. stocks are getting repriced versus foreign stocks. Between 2002 and 2004, this rebalancing happened largely because the value of the dollar was declining, dragging down the value of U.S. investments. But last year, when the dollar rallied, it was through relative stock prices. U.S. stock markets simply couldn’t keep up with rivals abroad.The same can be said of the bond market. Last year long-term U.S. Treasury securities underperformed long-term government bonds in Europe and Japan. Because bond yields move in the opposite direction of their prices, that’s another way of saying that U.S. interest rates rose relative to their overseas counterparts. Today, the yield on a 10-year U.S. Treasury note, 4.79%, is higher than yields in places like Germany, the U.K. and Japan . . .
The good news here is that Treasury bonds now provide overseas investors with better yields and U.S. stocks look cheaper relative to overseas stocks. That helps to keep attracting foreign capital. The bad news, says Mr. Prince, is that the repricing isn’t finished.
I am not sure its purely a currency issue, since it seems to persist regardless of whether the greenback is rallying or taking a dive. As the chart at top shows, it often peaks near an "event."
I’m curious if the yield has anything to do with the geopolitics of Iraq, our twin deficits, or something else entirely.
Thoughts?
>
Source:
Losing Ground
AHEAD OF THE TAPE
JUSTIN LAHART
March 29, 2006; Page C1
http://online.wsj.com/article/SB114359074458810581.html
well, if you are concerned about deficits, all the countries lists have higher debt to GDP ratios. . . so, I think we can rule that out.
The massive U.S. trade deficit would seem to be the obvious reason, as that implies that the value of the dollar will go down. Rates are relatively high in the U.K., which also has a big trade deficit, and low in Germany and Japan, which have trade surpluses…
i think 10YR traders/investors are looking at a couple of problems:
1> is the prospects of the Fed continuing to tighten which is causing negative carry on overnight positions. note the 2s/10s spread started to widen when the Fed took the funds rate above the coupon of current 10YR notes. this caused flatteners to be taken off and caused some steepening, driving 10YR yields higher.
2> is the prospects of the Fed finishing the tightening campaign which is putting pressure on the dollar and driving commodity prices back towards the upper end of their range (namely gold and oil). i think that the US bond market is as efficient a market out there and if the bond market doesnt’ think the Fed is tight enough, they will tighten for them through a steeper yield curve. we saw this when the Fed was ultra easy in 2003 and 2s/10s was 250+bps. back then everyone looked at nominal 10YR yields and couldn’t believe that they didn’t rise when the Fed was tightening, but if you think about it the yield curve was historically very wide and had already tightened, so as the Fed started to tighten off the 1% FF, the yield curve started to ease through a flatter spread. to me there was no conundrum then, the bond market was in front of the Fed. now that the bond market is looking at higher spreads and higher yields no matter what the Fed does. This is why the Fed is behind the curve (nice pun).
I may be wrong but it’s what i see and very few analysts were calling for higher 10YR yields and wider yield curve for 2006, therefore i think there is a good chance it happens.
as to BR’s point on risk premiums, i think that is exactly what the bond are telling us. they are tightening to offset the falling dollar and potential inflationary implications. the question is how much tightening will it require? that my friends, may be in the hands of the Asian central banks. stronger Yen and Yuan not good.
If you do a series of comparisons a la John Murphy, it sez (to me) that asset allocators will be looking to rebalance into Treasury issues out of sectors that have outperformed in the past 1-3 years esp those with high beta.
The equilibrium interest rate is the rate that attracts sufficient foreign capital to fill the savings-investment gap with a stable currency. It is just that over the last year or two it is taking larger and larger interest rate spreads to achieve this.
What you have to watch out for is the spread widening and the dollar falling. If you see that head for the hills.
Well Canada has a net surplus and lots of commodities. As for debt to GDP, I’m pretty sure it’s better than America’s currently.
Anyway for most countries, it’s taken 50 years to get to the current levels of debt to gdp. In the US it has taken 4.
Let’s face it, the American consumer is tapped out, government spending is out of control and taxes are low with lots of room to move up. Pensions are imploding and who knows who’ll be paying for health care!
America has been in denial for 20 years. It was easy to pretend being capitalists when boomers were in their 20s or 30s. Now that reserves have to be provided to match liabilities, capitalism is taking on a different meaning… It’s looking more and more like socialism!
As for many others in the developed countries, taxes have always been high so there’s room for cuts and consumers still have money to spend because they’ve been better savers.
Perhaps this is simplistic but this might highlight the fact that after all the big picture issues, relative values are an important part of overall market behavior and that in the medium term, like the chart shows, is the best way to see how when relative values push to a certain point the market “sees”, often enough, a corrective action. If this is true then it might be able to be seen in other ways…commodities, finished consumables, houses, and money. Just a guess but it seems worth a few more charts. These might be viewed as polar indicators.
Dr.’s Setzer and Roubini (especially the former in his blog) have done some important research on this.
http://www.rgemonitor.com/
I tend to think it is primarily a FOREX effect as it relates to globalization and emerging economies. The continuing and vast increase in US dollar liquiditiy and surge in highly leveraged derivatives, needs to be factored in as well.
Lot of global imbalances that are waiting to be corrected out there.
People forget that the Fed has major impact in the US bond market. They have decided on a higher short rate and will sell until they have a higher short rate market. This is not a free market we are talking about.
A CEO of a very large NYSE-listed Mexican company
is a good friend of mine. He told me over dinner
last year that his company was beginning to invest
its capitital away from the USA into Euros, yen and
British pounds.
And since foreign governments and companies
are major investors in the US bond markets, once
again common sense comes into play.
If you had billions to invest, would you put it all
into US dollars with all the inherent problems we all know about.
It is called “a lack of confidence” in our economy,
deficits, other imbalances and of course in our
political mess.
Japan has been in various stages of deflation much of this period, so you can throw them out right away.
Germany was always perceived as a very serious inflation hawk, so probably there is less of an inflationary premium built into their rates.
Canada, I think, is too small an issuer to compare with us.
The British are probably the best comparison of the group.
And versus the British, we are probably seen as more willing to inflate the currency, so we have to pay a higher premium in rates. But we aren’t all that far off from them either.
Cynic,
Bloomberg survey of 70 market participants, published March 8 of this year, showed a median estimate for the end of Q1 ten-year T-Note yield at 4.70%. End of Q2 4.80%. End of Q2, 2007 4.98%. After trading 4.957% just very recently, I’d guess the next round of estimates will show a somewhat higher median estimate for tens. Oh, well.
Just for fun, the Bloomberg median estimates for 10-year yields from the March 2005 survey were for an end-Q1 2006 yield of 5.10%, end Q2 5.20%. So, yeah, we really did get cozier with our flat curve.
see the FT’s 3/29 piece re article in Foreign Affairs: says our break-neck spending on nuclear arms is aimed not at ‘rogue states’ but at making sure Russia and China are destroyed in pre-emptive first strike and incapable of counter-strike. multiply that by our talk of bunker-busting tactical nukes vs Iran. we are scaring the rest of the world, no one likes us anymore, everyone is afraid of what we might do next. that will tend to raise your cost of borrowing.
As far as stock prices go, many countries with the exception of Japan (which historically had high prices and 2 decades of lows) have lower valuations. An evening would seem natutral in a true world economy.
Many of the Anglo Saxon states (GB, New Zealand, Australia) have pretty high interest rates.
The theme of that article seems to be grasping at something that isn’t there. The premium historically does not show such a correlation. To point to 2000 is not accurate because global indices were decimated. Many more than the S&P, Dow and nontechs in the US.
The circles on that chart are very subjective. I see a few other circles that should be drawn. And, isn’t it ironic the GB’s rates tend to correlate more to the US’s than the others?
If I were to look at that chart without the associated article, I would draw a couple of possible conclusions. 1) The US and GB have a more active policy to curb inflation. (NO laughing from the Fed cynics) 2) Both again may have more dynamic economies prone to overheating more so than the other two. So, if either of those are true, what are the implications? Runaway inflation in economies with less sophisticated central banks because money is too easy? Would be interesting to see China, India, Russia, Brazil, Argentina, Venezuela and a few others on there. If their central banks are being less diligent in a global asset boom, we’ll likely be importing inflation soon enough. Or, we’ll be exporting into an inflationary world and corporate America’s pricing power will be enormous. (Ring a bell? Profits as a percent of GDP at an all time high in the US) I think global risk is very, very high. If I were ever to want to be investing the in good ole US of A, it would be at the first sign that we are seeing global markets start to shake. It’s almost exclusively American money driving all of the international open markets. 40% of all derivatives globally are in the hands of US financial institutions. The majority of foreign investment in burgeoning economies is American money. The majority of VC capital is American. The GLOBAL sell programs that caused a minor shudder on Friday originated out of the US. Foreign investments as a form of diversification is sort of silly. For beta, hey, they are great. But, when America sneezes………
What will happen to the global markets if GM and Ford, two of the top five companies most often included in credit derivatives contracts globally, go down the crapper? How can F stay afloat if GM doesn’t? The MBS market is an unknown. Rates not moving in that market have a negative effect over time. There is simply no fear right now. Bond market, derivatives markets, stock markets, etc. I guess next week I am going long on full margin since commodities, energy and industrials are going to the moon.
I’m sort of curious. Europe has moved on a large PE expansion to catch up to the US even though their growth is half of ours. Japan has rocketed to the moon while the economy has done really nothing. (And neither have Japanese stocks OTHER than industrials, energy and commodities.) Where the hell is all of this global growth showing up in output? Japanese technology indices hasn’t moved throughout this entire cycle. Neither has the NAS sans a reflex rally in 2003. Where is the global growth of the consumer? Oh, right. It is there. In higher energy, commodity, inflationary and health care stocks.
Now, here is an interesting fact. The futures market in the ten year and thirty year bonds are diametrically opposed as far as future expectations. And, the open interest on these bets is enormous. Is wrong way Bill Gross at it again?
So, what does that tell us? Someone is going to be choking down some bitter medicine. And as they cover those bets, one side has the potential to make a big mess.
Given that there’s barely a duration risk premium right now, I doubt we have a credit risk premium on USTs. Furthermore, the ‘periods of higher risk’ were most likely caused by the Treasuries selling off first as in the last 3 springs, rather than the other way around.
Btw, Robert, I’m sure your friend is a good man so this is not an indictment of him in particular. But, I find it ironic that one of the most backward, corrupt, bankrupt, ill-managed, repressive economies on earth, Mexico, where people will risk everything to leave for the US, are going to diversify away from US assets.
How many crises has Mexico had? Including a few where we’ve bailed them out. What’s that about telling me to get the splinter out of my eye when you’ve got a bloody redwood in yours. That statement is almost laughable. He needs to worry about fixing the mess in Mexico. Talk about wage disparity between the elitists and the average worker. Mexico is a caste society prime for a revolt.
Also, in response to the “generally higher yield on US Treasuries versus other westernized nations (UK, Canada, Germany, Japan) “, surely this is due to higher GDP and CPI growth rates in the US vs those other countries.
The US has been running deficits for 30 years. I’m still confused as to how this has hurt the economy.
“America has been in denial for 20 years.”
Ok, at what point exactly is there going to be retribution? I am not saying it can’t happen, I just don’t understand the mechanism that supposed to punish the US for having these twin deficits and how we’ve managed to avoid it so far.
Somewhat related:
Ken Fisher on the CXO Advisory Site
http://www.cxoadvisory.com/blog/reviews/blog4-07-06/
Forecasting (Macro and Micro) and Future Concepts
Over the course of my career, I have learned many things that a lot of people do not believe. Differences in beliefs are fine with me. How else could I know something that others do not know?
For example, it is easy to prove that current account and trade deficits are not bad for an otherwise healthy economy. I know that fact and have publicly covered it a fair amount. The United States and most of the western world are not over-indebted but, in fact, markedly under-indebted and need more debt of almost any type. That assertion elicits an almost religious hostility from many people, but their anger does not negate the truth. They just do not want to believe it. I like that. When I see people freaking about a big current account deficit, I can bet against them. Understanding that we need more debt changes the way I think about many other things.
Anybody follow his stuff? I’d be interested in knowing more about his line of though.
I just read that link to Fisher. I’m nost sure I understand, or he understands the difference between deficits and debt as they seem to be used interchangeably. Btw, not an overly successful gent as it pertains to investments.
I like to view things in mathematical terms when appropriate. A simple rule of equality in mathematics goes something like this. If A=B and B=C then A=C. So, by basic mathematical principals of equality, Fisher is stating that all Americans individually need more debt. Now, since he is also an American, I’d think he’d be more than happy to buy me a new Ferrari Enzo and take the debt burden on himself.
Maybe you could email him and ask him to provide you with his mathematical or economic analysis to support his assertion. If it is compelling enough, you might want to nominate him for the Nobel Prize.
On second thought, I am going to log onto the Nobel Prize web site and nominate Fisher. But, before I do so, they will have to create a new category. I believe it would be titled “Stupidity”.
“The US has been running deficits for 30 years. I’m still confused as to how this has hurt the economy.
“America has been in denial for 20 years.”
Ok, at what point exactly is there going to be retribution? I am not saying it can’t happen, I just don’t understand the mechanism that supposed to punish the US for having these twin deficits and how we’ve managed to avoid it so far.”
I never put those two ideas together. When I said America was in denial, I meant about thinking of itself as a capitalist country when it is more socialist than it would like to believe.
i don’t follow his stuff because of this type of ridiculous reasoning. one reason the deficits haven’t mattered is because our 2 main trading partners have a psuedo-currency peg to the dollar. if the Yuan and Yen weren’t fixed to the dollar when the dollar was falling for period of 2000-2004 then we wouldn’t have been able to buy all that cheap shit at WMT. whether it’s t-shirts or flat screens, if they come from Asia to be sold at WMT we didn’t see any affects from the weak dollar. because that imbalance has persisted for so long the tremendous amounts of excess reserves were piled back into treasuries keeping rates low and consumers spending.
now how will it change? if China and Japan can get their own consumers to buy instead of save then they won’t need the US to buy thier goods. when that happens, they also won’t need to buy our treasuries and will allow their currencies to float. if that happens, that $2 t-shirt will cost maybe $3, $500 flat screen may cost $750 not a huge deal, but consider the macro affect of the Yuan and Yen appreciating by 50% v the dollar. then all of the sudden the deficits do matter and the Fed will have to continue to hike rates to defend the currency. you will see similar appreciation in consumer goods as we have seen in oil and gold.. it’s called inflation and it has been masked by the currency peg, but it’s evident in commodities and real estate. the FX market should be the great equalizer but it has been manipulated by central banks.
in other words deficits don’t matter until the do. when they do, it can get ugly. like 1987
i realize the situation is more complicated but to me this is the basic theme. Fisher sounds like he believes the propaganda from the Bush administration. would you rather believe the government or the market?? i’ll take the market
As for retribution, I can’t tell you the exact date because unilke Barry I haven’t looked at 2007 and 2008, 2009 or 2010 yet!
All I know is that:
1. Boomers haven’t saved enough
2. Pensions are imploding
3. Company healthcare plans are surely going to change.
4. The generation taking over the retiring one is smaller for the first time since the 1930s.
5. Current worker to retiree = 5/1. Within 1 or 2 decades = 2/1
Maybe I’m missing something, but I can’t help but think I’m going to have to be one helluva productive woman to get a full day’s work, put my kids through university and care for all the old people in my lfe when I’m 45-50!
Like I said, I can’t give you a date, but I can see it very clearly in my head and it’s not like 1995.
Barry its the plunge protection team manipulating those yeilds higher to keep the likes of China and other foreign investors from dumping all of that U.S. debt and dollars they hold. With more U.S. assets held by foreigners then ever in history (to my knowledge) they have a hell of a interest in manipulating the bond market. Just my two cents.
http://www.nasdaqtrader.blogspot.com
May I ask why China would dump all of our debt? You know, I’ll quote something here I don’t know anything about in detail because I’m not a applied mathematics genius.
A Nash equilibrium, named after John Nash, is a set of strategies, one for each player, such that no player has incentive to unilaterally change his action. That applies to situations that aren’t exactly cooperative.
Now, why would China dump all of those dollars when doing so would cut off the economic vitality that has almost entirely created its growth? While also creating an unknown outcome? There is no consumer in China. I mean NONE. Wealth has been created almost exclusively via exports in a very precarious manipulation by the centrally planned Politburo. Doing so would possibly create so much social instability that it would threaten the very existence of the Chinese government. And, it would also possibly create a Chinese deflationary mess similar to Japan. They know that. Why do you think they are moving so slowly with currency float? That is the primary reason. This is a socioeconomic hot potato for the entire world if China gets it wrong.
America is more likely to upset the equilibrium because we, on the other hand, can easily insert another country in China’s role in labor arbitrage. India? Vietnam? Cambodia? American companies will suck the blood out of someone else when China gets too expensive. Intel’s next factory is going to Vietnam. Taiwan, the largest investor in China, is moving its investments to other countries because China’s labor has become too expensive.
Why, oh why, does anyone want to dump investments with the standard by which all other investable debt instruments are measured? And why would a government want to commit suicide doing it? thecynic is correct that one day, while we’ve been waiting a century for it to happen, the rest of the world will create a consumer class. But, guess who wants that more than anyone? WE DO! So, we can have an economy where people save and the world’s output doesn’t go to hell in a handbasket. It would allow us to better handle our current fiscal mess if someone else would pick up the consumption expense. Without it, there continues a very unstable stability where the world finances our consumption. It’s good for them and it’s good for us. It’s like the wife married to the alcoholic husband who enables his behavior by buying him alcohol when he threatens her in some way. You don’t think the Fed and the rest of the economists in the world don’t understand this?
So, if we address all of our issues right now, what would happen? How about a global depression?
I don’t know about the “risk premium” in past cycles, but the current behavior of gold and oil may have something to do with this article out over the weekend:
http://www.newyorker.com/fact/content/articles/060417fa_fact
which Bush characterized as “wild speculation,” as reported here:
http://www.cnn.com/2006/POLITICS/04/10/bush.iran/index.html
I don’t know if calling something “wild speculation” is the same thing as a denial.
(Frankly, if the military is not engaging in some kind of contingency planning re Iran, they are shirking their responsibilities.)
Would appreciate guidance from the S&P, Moody’s and Fitch on what conditions would trigger a credit downgrade from AAA status.
George,
You ever see Planet of The Apes? That’s about what it would take. All of this talk of America going belly up is sort of silly. Not that we don’t have problems.
If an IQ test were to be administered on Wall Street, Stan Jonas would likely be at the top of the list. He’s not a salesman, he’s a mad scientist. Sort of the Albert Einstein of Wall Street. I saw someone ask him the exact same question you just asked. I’ll save your ego by leaving it at the reply was that such a notion was preposterous.
Now in twenty, thirty or forty years, who knows. But, I’d lose more sleep over whether I was going to get hot fudge or caramel on my sundae tonight.
I don’t think China will dump their treasuries without being seriously provoked. Given that they can’t sell them without losing a lot of money (because they would cause a market panic and prices would plummet), they are effectively giving the money away. In principle, they could take the money they are investing in treasuries and use it to buy their products directly. They could then burn those items if they have nothing better to do with them. It would produce the same immediate effect on the economy as buying treasuries so that Americans can afford to buy the products. It would just cut out the middleman. And maybe if they started giving them out, the poor of china would stop their occasional riots. Maybe they would even start to want an American-like consumer lifestyle.
I think China will only dump their treasuries as a prelude to war. Possibly for Taiwan, possibly for oil. Probably not for Iran. But most likely they are smart enough to know better than to go to war.
Yields are going to continue to rise for much of the reasons discussed here and also over here:
http://confusedcapitalist.blogspot.com/2006/03/lock-down-your-arms.html
Unfortunately, it’s not going to stop anytime soon – this is just the start of a long, slow, grinding progression. Rates going up, up, up ….
Jay Walker
The Confused Capitalist.
remember, China and Japan don’t have to “dump” treasuries to drive up rates.. all they have to do is not buy as many.. the bond market is very reflexive (to borrow Soros) as it is joined at the hip with the negative covexity of mortgages. as rates rise, fewer treasuries have to be held, thus driving up rates, thus requiring less treasuries to be held, thus driving up rates.. etc etc
the inverse of this was a huge factor in driving 10YR yields so low in the last few years. prepayments went through the roof and caused massive duration hedging buy mbs holders. it can become a snowball, on the way up just like on the way down
The Hindenburg Omen:
http://www.safehaven.com/article-4937.htm
Rather than focusing on China, it may be worthwhile to consider other large creditors such as oil exporting nations. I know, I know, official US flow of funds data doesn’t indicate that this is necessarily so, but then in a globalized financial system (which nation-centric catagories can’t capture), it may be better to deduce the origin of reflux by looking at things such as build up of surpluses. And on that count it looks as though the oil exporters will pull ahead of China this year. (Brad Setser’s weblog has, under the ‘oil’ label, a number of perspectives re. the above)
My point – high priced crude has created very large surpluses among that particular group of nations,,a substantial amount of these petrodollars have recycled into US T paper, making it vulnerable on a geopolitical basis as well as to oil price decline.
Someone mentioned Nash Equilibrium which, so far as I know, does not take account of _accumulating_ relative differences and how these can lead into a break. A process, let’s say what is in effect a global vendor financing, may be unequally beneficial for all parties but only up to that (in)famous point which, in retrospect, was so easy to see.
BTW probably worth noting that, for years, more than one-half of ‘China’s’ total exports have originated from the not-Chinese transnational sector. Re-export platforms have not been known to drive a rapid expansion of domestic consumers.