Depleted armoury to fight global downturn

Bond yields have tumbled globally in the past month in the latest leg to the rally that commenced last autumn.

Depleted armoury to fight global downturn

Bond yields have tumbled globally in the past month in the latest leg to the rally that commenced last autumn.

It has been a feeding frenzy in fixed income markets, recently, as investors act like a chasing pack, hunting down yield and duration everywhere.

The decline in bond yields has been spectacular. Ten-year Treasury yields fell to 2.35% from 2.75% at the start of March, having been as high as 3.25% last autumn.

Meanwhile, the US curve has inverted, with 10-year treasury yields dropping below short-term interest rates.

Even more dramatically, 10-year German bond yields have turned negative, falling close to -0.1% from 0.2% at the beginning of March and near 0.6% in the autumn.

Similarly, 10-year UK gilt yields have fallen by more than 30 basis points to below 1% in the past month. They were above 1.7% last October.

The recent gains in bond markets have been driven by the unexpectedly very soothing soundings on interest rates coming from central banks rather than a further weakening of economic activity. Data has remained soft but point to continuing moderate growth, not a recession.

Furthermore, much of the weakness is concentrated in the manufacturing sector.

Central banks, though, are making it clear that they will not risk allowing economies to fall back into recession and are almost offering markets a blank cheque.

At the start of the year, the Federal Reserve was predicting that US rates could rise by a further 75 basis points. Now it is says that rates could move in either direction. Indeed, markets think rates will be cut 50 basis points.

Meanwhile, the ECB has pushed out expected rate hikes into next year at the earliest, clearly signaling that rates will remain lower for longer, while also announcing new liquidity measures.

Indeed, ECB president Mario Draghi hinted last week that they might extend even further the period that they are guiding that interest rates are likely to remain unchanged at their current negative level.

It may be that central banks recognise that they have little ammunition to fight any major global downturn as interest rates are already very low, especially in mainland Europe.

Thus, they are acting pre-emptively to try and ensure that a recession does not occur, by using forward guidance on monetary policy to drive market interest rates lower.

And it is working. There has been a marked loosening of monetary and financial conditions recently.

We have seen a sharp drop in interest rates right along the curve, notably long-term yields, which are important in economies like the US and Germany, in terms of setting interest rates on borrowings for households and businesses.

ECB president Mario Draghi.
ECB president Mario Draghi.

Meanwhile, the rebound in stock markets in the first quarter of the year, which has seen them rise by around 10% year-to-date, also represents an easing in financial conditions.

These developments could lay the ground for a renewed pick-up in growth in the second half of the year, especially if there is also a resolution to the US-China trade war.

Such a rebound in activity would represent a job well done for central banks, but also highlight the difficulty they face in moving away from the current very low-interest rate environment.

Oliver Mangan is chief economist with AIB.

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