The bond market is at it again, upsetting just about everyone. Bonds are the most important financial asset yet attract relatively little popular attention, at least when compared to the newsflow that surrounds stocks – or even gold (the most insignificant asset). We only really became acquainted with bond markets when we discovered how much we and our banks owed them – and still do. Words like senior and subordinated, for a while, have entered into everyday conversations (well, of some people).
Politicians often seem surprised to discover the power of bonds. James Carville, a senior strategist and adviser to Bill Clinton famously described, in the early 1990s, with awe, the hold that bond investors have over policymakers “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody”. He was right then and his sentiments carry equal force today.
Perhaps it is because bonds are less interesting than stocks. You can tell stories about equity prices: ‘Microsoft’s share price fell massively because Bill Gates was seen using an iPad’, or something along those lines. Bonds are boring by comparison; it is far more difficult to link the price of a bond to exciting and personal stories. And bond prices go up when bond yields go down. That one gets just about everybody, even equity types.
But bond prices, and those pesky yields, affect everything, as Carville and the Irish taxpayer found out. All that Quantitative Easing by central banks has not been about printing money, not directly anyway: it’s a story about buying bonds. Bonds of all sorts that have been purchased in very large quantities. And the effects of those purchases? Most people would seem to prefer sawing their right leg off with a blunt penknife rather than seek to understand all of this. Yet it affects more people, globally, than anything else going on in financial markets right now. It also affects everything going on in financial markets, from commodities, to gold, to the oil price, to the value of emerging market currencies. And, of course, equity markets.
Led by US government bonds, prices everywhere are going down. That means that bond yields are going up. Most market commentators seem to think this is dreadful. Prices of bonds are falling because it is widely believed that the Federal Reserve and other central banks will buy fewer bonds in the future than they have done over the past few years. Why would that be so? It is because there is new evidence emerging, by the day, that the US economy (and, whisper it quietly, Europe) is getting better, perhaps a lot better. We might think that an improved economic outlook would make markets happy but, apparently, this is not so. As things get better, bond prices fall. We can understand that bit: the very low bond yields of the past few years are a direct result of the great recession. Bonds love recessions, especially when the downturn provokes central banks into those massive buying programs.
So, equity and other bond-linked markets are miserable right now – this can only be a relative remark since stock markets have only fallen a little. They have, over the past four years or so, risen an awful lot, anticipating, first, the end of the crisis and, second, the resumption of some semblance of financial normality.
If higher bond yields are upsetting some market types, let’s hope it gets a lot worse. Because those higher yields are, in fact, an indicator that normality might just be about to be restored. Bonds are not perfect forecasters by any means, but they are the best indicator we have. And the more those yields keep rising, the more normal things will be getting.
What is normal? In the US it might still be as much as 3 per cent growth, In Europe it is probably well south of that, perhaps even less than 1 per cent. Nothing that will make serious dent in unemployment. But that verges on a forecast, something this column has foresworn. Let’s hope for normal times, whatever that means, for however long it might last.
