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By Cleo Chang - July 25, 2019
Central banks working together is not necessarily a case of the tail wagging the dog. Rather, it’s the fact that there exist deep-rooted relationships in the global markets that affect how investors evaluate risks and returns.
Globally speaking, central banks have been very accommodative for many years. However, that doesn’t prevent investors from reacting negatively when they hear a more hawkish tone. The European Central Bank, the Bank of Japan and the Federal Reserve have all experienced this when attempting to take their feet off the easing pedal. With Europe and Japan not being able to move rates up in a meaningful way, it may serve as an anchor for what the U.S. can do.
Watch my latest video to find out where I think rates are headed and how global central bank efforts, as well as market disparities, affect investor perceptions.
I don’t think it’s necessarily the tail wagging the dog where the central banks are trying to work with each other for the sake of working with each other. It’s the fact that there’s these relationships that are deep-rooted in the global capital markets that does have effects on investors’ mindsets, especially in how they evaluate risk-adjusted returns.
Globally speaking, central banks have been very accommodative for many years. And, ECB [European Central Bank] has tried to take their foot off the easing pedal, and that actually has not been well received. The Bank of Japan has tried to use rhetoric to suggest that they may be taking their foot off the pedal on easing. That rhetoric has not been well received.
So, I think what you are seeing is not unique to the Federal Reserve. You’re seeing this being played out across the globe on all central banks trying to influence the capital markets through monetary policy, and investors globally reacting similarly, you know, when we hear a more hawkish tone coming from central banks.
I don’t think we’re far away from normalized rates. So, for example, a week ago the total negative yielding government bond issuance in the world was about 12 trillion dollars; that was at the beginning of last week. At the end of last week, that number creeped up from 12 trillion to 13 trillion. So, when you think about there’s that large of an amount of negative-yielding bonds, the U.S. 10-year Treasury yielding 2% seems quite attractive.
And because that backdrop of how the European and Japanese markets can’t seem to move their rates up in any meaningful way—that sort of serves as an anchor to where U.S. rates can go. It’s hard to fathom that you would have $13 trillion of negative-yielding bonds, and then here’s U.S. fixed income yielding in an historical normalized range of 3-5%. So, I think, you know, that complexity of the global nature of our capital markets plays into the role and is part of the reason why we are still in this low-yield environment here in the U.S.
I think that central banks obviously operate with some degree of independence. But what we have to appreciate is that global capital markets are a free-flowing world, at least for those countries that don’t have capital control. Right? And we have to understand when that disparity between similar instruments—say, a German government bond and U.S. government bond—when the yield disparity between them exceeds a certain range, it starts to affect other parts of the capital markets world because it affects the way investors evaluate risk and what is the appropriate risk-adjusted return.
Get additional insights in our latest Investment Outlook.
Negative interest rates—what are they, who’s using them and how might they affect the U.S. economy? Charles Tan, fixed income Co-CIO, breaks it down.
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Deep-rooted relationships in global capital markets may affect how investors evaluate risk-adjusted returns.
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