Bonds

"by bringing the royal treasures to Rome in his Alexandrian triumph he made ready money so abundant, that the rate of interest fell, and the value of real estate rose greatly." - Suetonius on Octavius (Augustus) in The Lives of the Twelve Caesars

Not a lot, it seems, has changed in two thousand years, at least in terms of the impact of an expansion in money supply on the cost of capital and thereby on all assets being priced against it.  Of course in first century Rome, Octavius was lending hard cash (gold) that was secured with tight asset coverage conditions, while today it is fiat credit that has been created in order to obscure structural deficits and toxic loans. This however, has meant that what was initially intended as a short term liquidity fix after 2008, has morphed into into a strategy for disguising structural deficits and public and private solvency crises; something it is dangerously unsuited for.  

An unintended consequence of Government/Central Bank attempts to manipulate asset values by artificially depressing Government bond yields has been to undermine market confidence in using these instruments as a proxy for the risk-free return, as we have highlighted in our Market ECC section. That is not to say that government bond yields, and particularly US Treasury yields no longer remain a crucial bellwether for equity markets, but that this has more to do with the signal these provide as to government's monetary policies and continued preparedness to pump liquidity into markets. As in Octavius's day, more supply, in this case of money/credit, the cheaper the price (interest rates) and consequential increase in alternative assets.  

10 year comparative yields

The Euro area is a fiscal basket case, lacks a guaranteed tax base for its fiat currency, yet its 10 year Govt bonds yield ob average approx -200bps less than a comparable US Treasury. 


QE, that has left the ECB 'balance sheet' at over 40% of Euro area GDP and over double that of the US Federal Reserve provide the explanation, as well as for the increased push for political union so as to secure the 'transfer union' needed to underpin the leverage before the proverbial wheels fall off.



Inflation expectations

Lower yields from QE have fortunately not overly distorted the gap between fixed and indexed linked (TIPS), which still provides an important metric for inflation expectations being priced in by markets. Few surprises here that these have broadly mirrored the ongoing rates of CPI.



Yield curve

The flattening of the yield curve is often cited as the prelude to recession, albeit this can sometimes persist for years without such an event. More relevant is when the short-end of the curve breaks lower following such a period as this is often an indication of central bank panic liquidity injections as it sees evidence of said recession. 

The Fed flip-flop from November 2018 and the recommencing of its 'non-QE QE' from Q3 2019 provides a somewhat worrying case of 'deja-vu' on this subject!