Kelly Evans: If bond yields don't start dropping....
Another morning, another move higher in bond yields. The U.S. 10-year Treasury yield is now making moves towards 4.7%. The 20-year just hit 5%. These moves are not happening in response to better economic data. They are happening globally, and even in places where the economy is tanking.
Take Germany, whose 10-year yields just hit a fresh twelve-year high...even as their economy has been in recession for three quarters and the outlook is so poor that it's causing national agita; "The sick man of Europe is back," and so forth.
Germany is actually a key example of what's going on with surging yields globally. They put all their chips on an energy transition (and on Russian natural gas as a "bridge" fuel) that is now resulting in structurally higher energy costs and hollowing out their once-vaunted industrial base. Worse, their own domestic auto makers were caught off-guard as Tesla and Chinese brands have led the transition to EVs. German industrial production, according to IFO, peaked in 2018. And its debt issuance jumped this year in part to fund the energy crisis stemming from Russia's war on Ukraine.
Here in the U.S., the envy of the world for our own cheap and plentiful natural gas supplies, we have echoes of the same problem. The price of U.S. benchmark crude oil hit $93 a barrel yesterday after we got word that key storage facilities in Cushing are at critically low levels. This will keep upward pressure on gasoline prices, which has already dented consumer confidence, and will continue nudging the CPI higher.
Traders say rising energy prices are one reason for the continued rise in global bond yields. "One may ask if policy makers fully thought through the various implications to markets, and in turn the economy, of their domestic energy priorities and policies before implementing them," one trading desk wrote this morning.
And the cost of funding the energy transition is just one of several reasons why global debt issuance has been soaring. There was the massive response to Covid, of course. Plus de-globalization and domestic support initiatives like America's "CHIPS Act" and infrastructure bills. And all of this--plus the previous decade's stimulus measures--done in an era of near-zero interest rates. Europe at one point had almost $10 trillion worth of negative yielding debt. Almost a quarter of government bonds globally had negative yields pre-pandemic!
Add it all up, and you're left with a massive debt pile, continued budget deficits, and an enormous amount of global government debt on the market competing for fewer structural buyers as central bank demand has dried up. "The epic sovereign bond bubble continues to unwind," wrote Peter Boockvar of Bleakley Advisors this morning. Prices for certain poster-child debt, like Australia's 100-year long bond, have crashed by 75% from their highs.
How much worse could it get? That's what investors are getting nervous about. "Looking ahead, the real risk to the economy, including financial stability, is if weak economic data doesn't result in falling long-term interest rates," warned Apollo's Torsten Slok in a client note this morning. The market's reaction to the jobs report next week, he added, "will be very important and likely set the tone for markets in Q4."
That is...if we get the jobs report. A U.S. government shutdown could send markets haywire, as it will halt the release of key reports like the jobs report Slok mentioned. It's not that the shutdown itself is the problem; it's that it prevents us from watching the market's reaction function. Indeed, a weak report would be the best salve for global markets right now if bond yields fell sharply as a result of it.
If yields don't start falling sharply on weaker data--as we're expected to get in the fourth quarter--investors will really start panicking. And if we're in a data blackout, they may just shoot first and ask questions later.
See you at 1 p.m!
Kelly