The U.S. Bond Market Fools Traders Once Again
U.S. Treasuries are, once again, proving to be a buy at almost any price. After the Federal Reserve’s surprise dovish turn this week, investors have piled into the $15.8 trillion market, leaving the 10-year note yielding less than 2.5 percent. Just a few months ago, it surged past 3.2 percent, sparking all sorts of talk — yet again — that this was the dawn of a new era of rising rates. Of course, one might be forgiven for wondering who would put money in 10-year Treasuries now, particularly when you can earn nearly as much in interest on a run-of-the-mill savings account from any number of banks. Yet for investors like JPMorgan Asset Management’s Alex Dryden, it’s perfectly sensible. The Fed’s darkening outlook about the U.S. economy is compounding worries over global growth, and few see inflation running hot enough to eat significantly into returns. If anything, the concern is that with inflation so low and growth so weak, yields will keep falling, which would make locking in today’s rates for years a smart move. “Inflation has been persistently and stubbornly low,” said Dryden, the firm’s global rates strategist. It’s not just in the U.S. where investors see weaker growth. In Canada, 10-year yields dropped below the overnight lending rate this week for the first time since 2008. The European Central Bank’s negative interest-rate policy means investors are still prepared to pay premiums to hold German debt due any time up to nine years from now. This month, the ECB slashed its 2019 growth forecast to 1.1 percent, the weakest in six years. On Friday, disappointing data from the German manufacturing sector reinforced concerns about euro-area growth, driving investors into haven assets globally. That pushed yields on 10-year U.S. notes below the rate on three-month T-bills for the first time since the financial crisis. It’s a worrisome sign because the inversion of the yield curve, as it’s known, has reliably predicted U.S. recessions over the past half-century.
ECB’s ‘Remarkable’ Formula Suggests More Easing Necessary
A policy formula the European Central Bank recently described as “remarkable” is suggesting it needs to ease monetary policy once again. A rule designed by former Governing Council member Athanasios Orphanides — praised by researchers at the ECB just after the end of quantitative easing was announced — says policy is now too tight, after months of weak economic data forced the central bank to lower its inflation outlook. The central bank predicts that price growth will average 1.5 percent in 2020 and 1.6 percent the following year, below the medium-term goal of below, but close to, 2 percent. “If the ECB had an inflation target between 1 percent and 1.5 percent, then their policy would be fine,” Orphanides said in a phone interview. “The rule is objectively suggesting what the ECB should do if it could act an independent institution — right now the rule says they should ease policy.” The central bank committed in March to keep interest rates low for longer and announced a new round of long-term bank loans. However, the stimulative impact of the measure is set to remain unclear for months as policy makers are still haggling over the details. The Orphanides rule links changes in interest rates to the gap between inflation projections one year ahead and the target, as well as the difference between forecast growth rates and those an economy can achieve in the long run. The main difference versus the Taylor Rule — which has inspired officials around the world since the early 1990s — is that it doesn’t consider difficult to measure concepts such as the output gap. “Because the rule can be implemented on the basis of short-term forecasts for growth and inflation that were available at the time of the policy decision, it is an easy way of constructing a real-time policy benchmark that is not contaminated by ex-post information,” Philipp Hartmann and Frank Smets, two of the ECB’s top economists, wrote in a December paper, one week after President Mario Draghi put a cap on asset purchases.
Russia Hints at Easing as Ruble Rally Helps Tame Inflation
The Bank of Russia said it may return to easing monetary policy this year after a currency rally and weak consumer demand helped blunt a spike in inflation. The regulator kept its key rate on hold at 7.75 percent for a second straight meeting, according to a statement on Friday. That matched all 40 forecasts in a Bloomberg survey. Policy makers also lowered their year-end inflation forecast to 4.7 percent-5.2 percent from an earlier estimate of 5 percent-5.5 percent. “We will be able to look at moving to rate cuts a lot earlier than we forecast in December if our base-case scenario plays out,” Governor Elvira Nabiullina said at a news conference in Moscow. She declined to comment on the timing of potential easing this year, but said the key rate won’t get back to its “neutral level” of about 6 percent to 7 percent until 2020. The comments mark the first major signal from the central bank that the inflation danger has past from a value-added tax increase at the beginning of the year. After three years of easing, the regulator surprised the market by hiking twice in 2018 to preemptively tame inflation. In the end, the tax hike didn’t have as big an impact on prices as expected because retailers took most of the blow. The ruble’s rally, along with falling gasoline prices, further eased pressures. Annual inflation quickened to 5.3 percent as of March 18, well above the central bank’s 4 percent target. While most of the impact of the VAT increase has already been felt, some deferred effects may appear in the coming months, Friday’s statement said. Investors have been piling into Russian bonds as concerns about a potential new round of U.S. sanctions abate, sending the ruble up about 9 percent against the dollar this year. Federal Reserve Chairman Jerome Powell gave fresh impetus to a rally in emerging markets this week with a surprise forecast for no rate increases in 2019.
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