The Short View

September 5, 2013 7:38 pm

Bond yields defy forward rates guidance

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Market has moved ahead of what the central banks want

Here’s a shorter version of Mario Draghi’s explanation of the forward rates guidance from the European Central Bank he presides over: “Don’t worry, we’ve got this”.

The US Federal Reserve is more precise: it has a target for unemployment, and provides its policy makers’ forecasts of interest rates up to 2015. In between is the Bank of England, which refuses to limit itself like the Fed but cannot quite bring itself to embrace Mr Draghi’s Latin ambiguity.

The market reaction? “Whatever”. Bond yields have carried on up, ignoring all three. Yesterday the US 10-year yield returned to where it was before fears of a credit rating downgrade prompted a (counter-intuitive) flight to the safety of US bonds in July 2011. Gilt yields jumped above 3 per cent, again the first time in two years. And the 10-year Bund yield passed 2 per cent, not seen since the misplaced optimism of March last year.

Rising yields suggest a strong economic recovery, which is starting to be reflected in some data, will force the central banks to dump their guidance and raise rates.

The market has moved far ahead of what the central banks want. While they all expect growth, they have been warning investors that rate hikes are priced in far earlier than can be expected.

Consider the US. All but four of its 19 policy makers forecast in June that rates would still be on the floor at the end of next year. Futures markets now give odds better than 50:50 of a rise by October 2014 – and a one-in-five chance of three 25bp rises by January 2015.

Bond market optimism about growth is not reflected among economists. The private sector consensus remains more bearish than central banks, and US forecasts for next year’s growth have actually been trimmed slightly since January.

Bond markets are more likely to be right than economists. But central bankers are economists with monetary weaponry. Those selling bonds need to be sure central bankers will not back up their words with action.

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