Are Global Central Banks Shooting Blanks?

Bond yields are sliding as economists mark down their global economic growth projections. The benchmark 10-year US Treasury yield has plunged more than half of one percentage point to 1.6 per cent over the last four weeks, hitting its lowest rate since 2016. The German 10-year yield has similarly slid; the only difference is the bund sports a negative 0.65 per cent yield. While the largest share of bond buying over the last decade could be attributed to central banks – the collective balance sheets of the  Fed, ECB and BoJ now total more than $14 trillion – this time around private investors are the biggest buyers. In fact, the Federal Reserve’s portfolio of Treasuries and mortgages is more than $700 smaller since its quantitative easing program ended in 2014.

Private investors, unlike monetary policymakers and banks, are purchasing longer-maturity bonds by choice. The most recent flight to safety suggests investors believe anticipate a global slowdown or perhaps recession.

The yield differential between 2-year maturities and 10-year maturities imply a projected future rate path. When the differential is wide – with the 10-year yield substantially higher than the 2-year yield – investors anticipate a rising interest rate environment. An inverted yield curve, on the other hand, has historically implied recession. The US and UK yield curves have flattened dramatically since the beginning of 2017 and are at their flattest point since the financial crisis. In fact, both the US and UK curves inverted this morning. The recent capital shift is affecting global equity markets: month to date, global equity markets have been selling off.

There’s a growing narrative that the world’s central banks, having gone “all in” to combat the 2008 financial crisis, no longer have the firepower to battle the next downturn. The bond market’s rally in response to the Fed’s most recent rate cut exemplifies that view. The yield on the 10-year note has fallen .45 per cent and the curve is .17 per cent flatter since Powell’s July 30 move to boost growth. It’s as if the global economy is driving around without a spare tire. Though the likelihood of an imminent recession appears low, the prospect of fixing a flat without effective monetary policy tools is a broadening concern.

In the future, lawmakers facing down the next economic recession could embrace Modern Monetary Theory, a logical extension of quantitative easing: the idea of deploying printed money for fiscal spending, like infrastructure, to boost growth. Stay tuned.

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