yields

Research from the Bank of Japan argues that we are seeing a multiplier effect in capital flows between emerging markets and the US, and its reversal could cause a very sudden upward correction in US government bond prices.

The argument runs along these lines: investors seeking high returns have caused large capital inflows into emerging markets, causing forex intervention and leaving governments with stockpiles of US dollars. Those dollars are then invested in US treasuries, reducing the yield and making it cheaper for US investors to borrow – and to seek high returns in emerging markets. Repeat.

While no direct mention is made of the Fed’s recent $600bn stimulus, 

€2.3bn government bonds bought by the ECB settled last week, taking the emergency assistance back up to levels last seen during the Irish bail-out. Many of the bonds bought are likely to have been Portuguese, in particular during its debt auction on January 12 at which bond yields fell.

The value of bonds settling last week was 20 times that of the week before. Yields have been extremely volatile of late in struggling eurozone economies, including the “periphery” and Belgium. The cost of Greek and Portuguese debt is still falling following the latest interventions and market-calming discussions, but yields in Spain, Italy and Belgium are all rising once again.

The key level of 8 per cent has been rapidly passed today by rising Irish ten-year bond yields. London clearing house LCH.Clearnet has now moved to protect itself from any possible restructure, by making it more expensive to trade Irish debt.

LCH.Clearnet, the world’s second largest fixed income clearing house, said an additional 15 per cent margin requirement would be charged on investors’ net exposure to Irish bonds because of the increasing risk of a sovereign default. It’s another blow, following news that some SWFs were divesting Irish and Portuguese debt. The ECB is apparently buying Irish debt yet again.

Tension rose today following a Portuguese debt auction. Lisbon did sell €686m 10-year bonds and €556m 6-year bonds, less than the guideline range, which was €750-1250m in both cases. (Selling less than the guideline amount has been a feature of Portuguese debt auctions since July.)

Yields, however, were punitive. Lisbon will pay 6.81 per cent 

All eyes on tomorrow’s €1.5bn Irish bond offering. As investors have become more nervous, the head of the central bank has called on the government to rethink some of its austerity plans:

“I think these kinds of budgetary programmes do need to be reprogrammed in the light of circumstances,” Patrick Honohan told an audience today at a regulatory conference in Dublin. 

Might the Fed cap long-dated Treasury yields? This suggestion, made by Bernanke himself in 2002, has resurfaced in the blogosphere amid rising fears of deflation.

In recent days, the Washington Post’s Neil Irwin and the New York Times’ Paul Krugman have both asked what the Fed can usefully do if there is another slowdown. The meticulous Bill McBride, the man behind Calculated Risk blog, offers an insight into Bernanke’s ‘roadmap’. The speech might be old, but the thinking seems more relevant than ever.

Over to Bernanke:

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure–that is, rates on government bonds of longer maturities.

There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination.

 

The US government can borrow from the market for five years at a rate 2.6 percentage points lower than for Portugal. Bond yields continue to fall for medium-term US debt (they fell yesterday for 2-year bonds too), even though very short-term debt rose (4-week treasuries reverse trend (Jun 22)).

The medium yield was 1.925 per cent, down from 2.07 per cent at the last auction on May 26. Tomorrow is the 7-year auction: on current trend, the rate will be lower than a month ago, when it was 2.75 per cent.

Well, they couldn’t go much lower. Yields have risen in the latest auction of 28-day treasuries, as the bid-to-cover fell to 3.7, the lowest since April 6. The flight to safety had pushed the cost of this short-term debt almost to zero at the last auction.