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Fears of rising dollar interest rates upset financial markets around the world. Every asset is a claim of an income stream extending into future periods, and the value of the income from the more distant periods is discounted more heavily than the income from nearby periods. A cardinal principle of investment is therefore that the higher the rate of discount, the lower is the price of assets. Meanwhile, the influence of American interest rates is global and pervasive. Even investors in Japanese tech stocks and German commercial property know that they must watch movements in American bond yields and the funds rate set by the Federal Reserve.

The Fed kept its funds rate at between zero and 0.25 per cent for seven years from the end of 2008, to help borrowers and asset prices, and to ease the American economy out of the Great Recession. Although it started to edge interest rates upwards from early 2016, even in the summer of that year the yield on 10-year fixed-interest Treasury bonds was as low as 1.5 per cent and policy tightening seemed gentle. But 2018 has seen a resurgence of inflation worries: the Fed funds rate is now over 2 per cent and the 10-year yield has climbed to above 3.2 per cent. In a Daily Telegraph story last month, Ambrose Evans-Pritchard warned that the doubling of American bond yields in little more than two years might “trigger a debt meltdown”.

A doubling of American bond yields in a relatively short period of time does matter. The psychology of financial operators may be shifting, with even the glamour stocks of the American bull market tumbling since mid-September. But a curious feature of the current upturn in bond yields is the short memory of today’s market commentators. In the context of the last decade, a doubling of American bond yields is a big event; in the context of the almost 75 years since the Second World War, a yield shift from 1.5 per cent to 3.2 per cent is trivial.

Let us look, first, at American bond yields in their biggest and worst bear market of all time, from the mid-1950s to 1981. For much of 1954 the 10-year Treasury yield was about 2.3 per cent, with the American public and the US’s investing institutions confident that their nation would prevent inflation and maintain the real value of their currency. Over the next generation this confidence was shattered. Several years in the 1970s suffered annual increases in the producer price index of over 10 per cent and a few were still worse at more than 15 per cent. A 15-per-cent-a-year inflation rate halves the value of money in five years. No wonder that investors fled the bond market, with the 10-year Treasury yield climbing briefly to over 15 per cent in late 1981. Obviously, the US government debt meltdown over the 27 years to 1981 — with yields rising more than six times — overshadows what has happened since the summer of 2016.
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untenured
November 1st, 2018
11:11 AM
The truth about the continuing decline of Sterling since the end of WWll is very simple. In celebration of our victory, we awarded ourselves a raft of unaffordable goodies, the NHS being just one, and have been "paying" for them with a judicious combination of borrowing and devaluation. In other words, the Socialist delusion. Socialism takes no interest in paying for anything. The true socialist just has to identify the scapegoats who obstruct it and drop them in the shredder. The Germans, as you might expect, made an industrial process of it. To address the main part of your article regarding the possible bond meltdown, we are still in the grip of ZIRP, now approaching its tenth birthday. The ultimate counter-party to the borrowing by the Rest of the World is the USA, whose torrent of debt has fuelled a Dutch Auction of capital, which, in turn, brought interest rates to zero and below. The Fed has been raising rates with the miraculous result of booming profits in the US banking community.One explanation is that the Fed has been giving the banks a turn dressed up as some sort of repo. Another consequence of the Fed's hiking rates is to spook countries to raise theirs to no good purpose: there was a continual downward trend until Nov 30 2017 when South Korea went to 1.5%, then we have seen a procession, starting with Mexico and ending with Canada, of increases. No sign of Japan or the benighted EU bothering! Further increases by the Fed would be an exercise in testing the viability of economies dependent on zero interest rates.

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