Why markets no longer seem to trust central banks to steer the economy
There are perhaps as many answers to the question of what explains the growing disconnect between central bank actions and long-term bond yields, as there are economists and market players.
Some would attribute it to ballooning public debt, especially in advanced countries and hence the markets’ acknowledgement of fiscal realities dominating all other concerns.
Others would put it down to plain fear, regarding the growth outlook in an environment where expansion is already slowing, geopolitical tensions are rising and the end to the war in West Asia seems like a short-won reprieve, not a long-term solution.
Yet others would attribute it to the persistence of inflation.
What is clear is that long-term bond yields—they move inversely to prices—have risen globally. What is also apparent, though not explicitly stated, is that central banks as a collective seem to have lost the faith of markets. So, it is no longer a case of markets following central banks looking for cues from them.
Rather, it is a case of markets reading the signals and setting their own agenda, regardless of what the central banks say or do. In any case, most central banks have stopped giving guidance as the future has become much too unpredictable. In such a scenario, it remains to be seen if central banks will follow markets instead of the other way round.
This question is important because it comes at a juncture when central banks globally are expected to cut rates (or at best maintain status quo) in a bid to support growth.
Whether it is the US, where President Donald Trump has been berating Federal Reserve chair Jerome Powell for not cutting the Fed rate aggressively enough, never mind that the Fed did cut rates at its last meeting late October. Or it is the UK and India where central banks have cut rates, and yet long-term bond yields have moved up, rather than down.
In the US, for instance, when the Fed cut its policy rate by 25 basis points on 29 October, the 30-year bond yield moved up from 4.59% on 29 October to 4.70% on 7 November. The picture is no different in other advanced economies such as the UK, France and Germany.
In India, the Reserve Bank of India (RBI) has cut rates by 100 basis points since February. But the 10-year bond yield has fluctuated between a low of 6.16% on 28 May and 6.51% on 6 November, leading RBI to convey its unease to market participants.
Liquidity management by RBI has not been able to prevent the upward pressure. The increase is across tenors but greater for longer ones, suggesting that markets are far from optimistic about what the future holds.
The yield curve for government bonds, which gives the yield on bonds over different terms to maturity, affects interest rates of a range of instruments in the economy. An increase in interest rates on risk-free government bonds raises the interest rates on all other bonds, in turn lifting the general level of interest rates in the country and acting as a dampener on investment and economic growth.
The message is clear. Markets are worried about inflation, deficits and debt sustainability and have less confidence in the ability of central banks to keep interest rates low through monetary easing. The famed ‘Greenspan put’ (wherein the Fed bought government bonds to ensure yields stayed low) is now beyond its sell-by date.
For central banks, for whom credibility is the most important weapon in their armoury, this is a worrying sign.
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