A normal cost of capital is a form of much-needed discipline for governments and investors, after years of free money turned their brains to mush.
By Wolf Richter for WOLF STREET.
The 10-year yield of UK government securities rose to 4.82% today, the highest since July 2008. The 30-year gilt yield rose at one point today to 5.47%, the highest since 1998, though it backed down to 5.38%. So the UK is a little ahead of US Treasury yields (4.69% and 4.93% respectively).
There was a lot of handwringing in the financial media today and recently about those surging yields, with terms like “gilt market rout” getting into the headlines, and some even seeing a “return of the bond vigilantes,” etc. etc. But wait a minute…
Back on July 29, 2020, the 10-year gilt yield had dropped to an all-time low of 0.09%, back when everyone holding gilts was clamoring for yields to go negative because these holders would benefit from falling yields because bond prices rise when yields fall, and that path into the negative would be the necessary and logical continuation of the 40-year bond bull market and make it an eternal bond bull market, with yields falling ever deeper into the negative, or whatever.
But that final descent from the range of 4-5% in 2008 to near-0% in 2020 was caused by global interest rate repression, with the Bank of England cutting its Bank Rate to near 0% and keeping it there for 14 years (ZIRP), accompanied during some periods by large-scale QE.
Then inflation took off in 2021. The BoE eventually hiked its Bank Rate to 5.25%, and QE flipped to QT. After two careful rate cuts last year, the BoE’s Bank Rate is still 4.75%.
But the thing is, today’s 10-year gilt yield is back in the normal range – normal before ZIRP and QE. It’s actually at the low end of the normal range, and just barely above the BoE’s short-term Bank Rate. It’s at the low end of where it should be in normal times.
The return to normal, after those crazy years, should be seen as a good thing, even if sorting out some of the excesses of those crazy years isn’t always easy.
And a normal cost of capital, provided by the bond market, is a form of much-needed discipline for governments and investors, after years of free money had turned their brains to mush.
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Evidently calling it the British pound “peso” now I was reading.
The real peso is the Canadian dollar which seems determined to make a trip below 70 cents. I can remember when it was actually worth $1.04 US. That seems like a lifetime ago and how did they manage to screw things up so much since then?
It’s not complicated. Oil was over $140 a barrel.
The Canadian peso is heading to 50 cents
Is there actually that much speculation in the bond market? I always thought the bond market was where you parked your money.
Plenty of speculation in the bond market.
But it is funny that Bonds are traditionally viewed as the safe investment. I guess 40 years of conditioning will do that but will be interesting if that though process changes when bonds have another couple years like 2022
“And a normal cost of capital, provided by the bond market, is a form of much-needed discipline for governments and investors, after years of free money had turned their brains to mush.”
Exactly!
Why do you call the 4-8% yield ‘normal’ when the preceding decade it was much higher and post 2008 it was much lower?
As I explained in the article (go ahead and read it, it’s very short, and it doesn’t bite): post-2008 yields were abnormally low due to QE and ZIRP. Those were new inventions that massively backfired globally, and now we have inflation like we haven’t had in four decades, and it’s sticking around, and it’s messing things up.
If you look back to the 1960s, you will see that 4-8% was normal until very high inflation arrived in the late 1970s.
So since 1960, over those 64 years, there were two exceptional periods, the 7 years of above 8% yields (1978-1986) and then the period of QE and ZIRP (2009-2022) when yields were below 4%.
You’re not looking back far enough to establish the ‘normal’ rate. Rates have been steadily declining since the middle ages in a ‘suprasecular stagnation’. The reason is primarily thermodynamic. After 2008, the wheels came off the growth paradigm and rates were brought down so low to kick the can down the road.
https://cepr.org/sites/default/files/styles/popup_small/public/image/FromMay2014/schmelsingfig2.png?itok=vG5mra2e
Philip posted further down this:
“The past 750 years of bond yields can be found here:
https://globalfinancialdata.com/750-years-of-interest-rates
“Looking at the graphs, I would guess most of the data points are between 4% and 6%. This is data boing back to 1285AD.”
👍👍
Well, there may have been some undue distortions. Just MAYBE though.
Janet Yellen even admitted that the pandemic stimulus (another *possible* distortion?) MAY have contributed “a little bit” to inflation.
Then we see the rotation in governing powers, by election, resignation… REelection. I seem to remember a (more than?) slight panic in the Gilt market a few years ago based upon this? (Oct. ‘22)
The US 10 year is obviously in higher demand (as the article notes the slightly lower yield). I can’t imagine another reason why the UK would have a higher yield? Certainly not on growth expectations.
“The US 10 year is obviously in higher demand. I can’t imagine another reason why the UK would have a higher yield?”
That IS the reason. Less demand.
Treasuries are the gold standard for pristine collateral – not Glits.
“The US 10 year is obviously in higher demand (as the article notes the slightly lower yield). I can’t imagine another reason why the UK would have a higher yield? ”
Yup! At this moment it looks like no one wants to hold gilts because they feel the UK is going to be Argentina or a third world country soon. Given the quagmire they seem to be in and the squabblers running the show, they do ot seem to be wrong either.
“A normal cost of capital is a form of much-needed discipline for governments and investors, after years of free money turned their brains to mush.”
Well said.
Lines up with the belief that a mortgage rate of 6 -7 is abnormally high, when it is actually a return to normal.
Yields will crash this year. There is a global recession starting. China is in trouble because the global consumer is in trouble. They make the world’s things. The first place that gets it are the manufacturing hubs.
“Tell me you’re a bond bull without telling me you’re a bond bull”
This will undoubtedly be true given enough time. That is always the tricky part of investing.
I agree with Wolf. The past 750 years of bond yields can be found here:
https://globalfinancialdata.com/750-years-of-interest-rates
Looking at the graphs, I would guess most of the data points are between 4% and 6%. This is data boing back to 1285AD.
Back when rates hit an artificial bottom, a London banker opined that they were the lowest REAL rates in 5000 years.
Back to now, a Canadian couple has decided to sell house and downsize to condo because their 5 year term is up. It was at 2,2 % !
That’s like a rate from the early 19 hundreds.
The bank has been way underwater on that deal for at least 2 yrs.
RBC’s GIC was 4.6 % two years ago.
You can see where the Ottoman–Venetian War (1463–1479) really messed up interest rates.
I bought a dozen eggs at Kroger and they $5 — shelves bare.
A quick search reveals that a tsunami of farm workers will be leaving jobs before deportation raids begin.
That eventually will connect to yields drifting g higher, as a perception and expectation that inflation will stay elevated and the deficit interest costs will grow.
I honestly thought inflation might surprise to the downside this qtr — my eggs tell me I’m wrong.
$5?? Lucky you. Trader Joe’s here has been out of eggs for weeks. I went to Costco on Saturday, and they were out of eggs too.
But LOL, this has nothing to do with farm workers or the yield curve or whatever, but with the avian flu that has been raging for months. Did you somehow miss?
We bought eggs on Amazon for $2.50 per dozen in the last month and they came in perfectly for Amazon Fresh delivery.
Higher coupon yields are simply a predictable reversion to the mean.
#ShortTLT
MSN: BANK OF AMERICA Braces for Massive Bond Losses as Yields Soar
CNN: A zombie mall store king is born as JCPenney merges with Forever 21 owner
JCPenney is merging with a company that owns a number of other once-bankrupt clothing stores, including Forever 21 and Brooks Brothers, to form a new company that will hold significant sway over the future of America’s malls.
The 123-year-old department store chain anchors the new company — a joint venture with Sparc Group, which also owns Lucky Brand, Eddie Bauer, Nautica and Aeropostale. The merger will form a new company called Catalyst Brands, representing a gamble that combining the beleaguered brands will create a new powerhouse of mall staples … that also happen to have America’s largest mall operators as major financial backers.
Catalyst represents a new chapter for JCPenney, the historic chain that filed for bankruptcy in the height of the pandemic in 2020. It was later bought by mall-owner Simon Property Group and real estate developer Brookfield in a $1.75 billion deal.
“A normal cost of capital is a form of much-needed discipline for governments and investors”
It took 10 years and sticky inflation to understand this at the central banks. Ask any housewife, who has a tight budget to run a household, anywhere in the world about cost of capital and disciplined spending. They would answer it in a jiffy. Just goes to show an ounce of common sense is worth more than all the PhDs in the world and common sense cannot be taught at Universities.
Sadly, these clowns have the keys to the house and run the monetary policy circus without this basic understanding.
I was thinking the exact same thing myself today. Why didn’t the Democrats realize that they were going to get hammered by inflation? Instead of doing something about it, they just added more fuel to the fire. Talk about clueless.
Because the Democrats response to everything now is simply to say “don’t worry your pretty little head” and then go bury their own in the sand. They only hear what they want to hear
Stick around, see if it gets better or worse.
The investors are picking up the brainrot from the zoomer generation giggity skibidi no cap
The yield spreads between gilts from the developed and the emerging markets are becoming narrower. As wolf mentioned in his previous article, the returns from foreign investors in dollar terms was flat or negligible due to the decline of foreign currencies against dollar. There is some sobering to be had for the foreign investors, expect them to bring back their dollars into the US equities and bonds..
MW: LA wildfires to cost insurers more than $20 billion. Three companies are likely to foot most of the bill.
J.P. Morgan doubles previous insurance-loss estimate; Allstate, Chubb and Travelers most affected.
Insurance companies are bracing for more than $20 billion in insurance losses from the wildfires raging in the Los Angeles area, analysts at J.P. Morgan said Thursday, doubling their insurance-loss estimates from a day earlier.
LA wildfires have caused more than $135 billion in economic losses — and counting…
Clueless as always Paul Krugman thinks bond yields may be rising due to an ‘insanity premium’…
All folks talking about bond yields centuries ago…this was on a strict gold/ silver standard. Fiat money hadn’t been invented until late 1700 hundreds with scammer John Law, treasurer to King of France.
No one traded bonds 750 years ago. Sure, there was money, i.e. gold. lent at interest, but this did not constitute a functioning market in debt.
Reason ONE: the monarchs would repeatedly renounce the debt, and retreat to argument by force of arms,