A remarkably fast rise in yields is taking place in Europe: French 10-year T-bonds had stood at 0.36% as of the middle of April; today they are at 0.83%, which is a 5-month high. German 10-years T-bonds were at an all-time low only a few days ago, with a yield of 0.075%. Now they are seven times higher, where they have not been since the end of 2014. But these are not the only yields on the rise: Spanish, Portuguese, Italian, Irish, Belgian et al have all moved higher. Even British and American bond yields are on the way up. So what is behind these sudden and sharp moves?
We have already seen the contradictory nature of Quantitative Easing (QE) at work in the US, which can be summarized thusly: If the central bank starts buying up treasuries, that will cause yields to fall, while simultaneously pushing the price of treasuries up, as well as those of all other assets, too, and pump fresh blood through the economy. That in turn will spur growth and/or inflation, and bring about a healthier and stronger economy, at which point the QE program may cease. And since sooner or later an interest rate hike must take place, assuming a strong economy, treasury yields should not fall, but rather begin to rise. Thus it is that the central bank purchasing treasuries (in theory driving their price higher, on increased demand) in paradox fashion causes their price to fall (= rising yields). It is then no surprise that yields tended to rise under the Fed’s QE program (falling bond prices), but as QE ceased, bond prices rose (even though the Fed was not buying treasuries at that time).
Something similar is going on in Europe right now. Despite the European Central Bank’s outsized buying of treasuries since January, it is exactly the success of the QE program (= weakening euro, collapsing yields, rising stock prices and rejuvenated lending) that leads one to think that Europe will avoid the Japanese trap: there will be no prolonged deflation or recession, so interest rates cannot stay at zero forever. And therefore there is no rationale for treasuries to go negative or stay at yields near zero, which means that despite the central bank purchasing treasuries, investors are fleeing from them, and selling.
The current European-wide (including the Anglos) rise in yields is in fact very good news. It suggests that Europe is on the right track and will not get bogged down. This is a new development, and it is quite possible that yields could go even higher, perhaps rising another 0.5-1.5% in the coming weeks and months. That could be a frightening development, and it does appear that European stock markets have been spooked. If their fear continues to grow, that will be a great buying opportunity, for even if German yields were to rise to 2%, stocks would still remain attractive on a relative value basis, and once the panic had subsided, the bull run in European stocks would continue – of course the question of from what price level remains to be seen…
The domestic (Hungarian) impact of all this could be a temporary weakening of the forint and a rise in treasury yields, but neither occurrence should be a cause for concern.
Written by Viktor Zsiday May 6th, 2015