One Size Fits None_


Extract from our "One Size Fits None" research paper, published 7th May 2021

In contrast to the past, bond yields in the US seem to be dictated more by supply-demand forces in the global capital markets, rather than the state and the outlook of the US economy. Despite the sharp rise in the US bond yields this year, the levels of the US yield curve are too low relative to the economic fundamentals of the US; however, they may be too high for much of the rest of the world. This ‘one size fits none’ configuration of US interest rates will, we believe, lead to a further divergence in economic growth beyond the immediate bounce in economic data, as economies reopen.

  1. US long bond yields no longer fully reflect the current or the expected performance of the US economy, with the correlations remaining low and unstable by historical standards.
  2. Quantitative easing (QE) by various central banks has imparted considerable distortions in the global financial markets. Not only have bond yields been artificially depressed around the world, the composition of the global pool of safe haven sovereign bonds has changed dramatically in the past decade or so, with the US Treasuries having become twice as dominant in the world now compared to 2007. This is a point we first made in 2019: ‘US Treasuries as a Safe Haven: 70% More Dominant than in 2008,’ (July 26, 2019). If the current QE trends persist, US Treasuries could, a year from now, account for 65% of the global pool safe haven bonds, leaving global savers few options but to hold more US Treasuries.
  3. China’s State Administration of Foreign Exchange (SAFE) has most likely been divesting from the USD and the US Treasuries for logical tactical reasons: if the risks of financial sanctions by the US are rising, why would SAFE hold so much US Treasuries that could potentially one day be subject to confiscation or be frozen? While foreign central banks’ demand for the US Treasuries has stalled, domestic US buyers of Treasuries have fully offset this divestment by foreign central banks. Private foreign demand for the US Treasuries has also remained strong, and their share of the UST market has remained constant in recent years.
  4. The rise in the US Treasury 10Y yield since the start of the year has caused other bond yields to rise, especially in some emerging market (EM) economies. For example, long bond yields have risen by 500%, 100%, and 240% in Turkey, Russia, and Brazil respectively, so far this year, even though their economies are not expected to experience nearly as robust a rejuvenation in the coming years as the US should. Continued rise in the US Treasury yields, thus, will likely exert disproportionate pressures on other parts of the world, exacerbating the economic divergences in the world.

Bottom Line

We make a simple point in this note, that the US yield curve will likely remain too low relative to what the US economy needs or deserves. Financial repression by the major central banks in the world has been too successful in driving bond vigilantes into extinction. This means that US bond yields will likely remain too low for the US economy but could be too high for some other parts of the world, thereby accentuating growth divergences around the world. Having said this, in the long run, the severed relationship between the economy and the yield curve will likely lead to serious moral hazard problems for policy makers.

Extract from One Size Fits None, published 7th May 2021

Sections included within this report are:

  • Long bond yield and nominal GDP growth
  • Global financial repression to keep US Treasury yields artificially low
  • One size fits none
  • Central banks’ holdings of USDs don’t matter that much for either the dollar or the US Treasuries
  • The bond market is a poor source of information for the economy
  • Inflation targeting framework to come under scrutiny

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