From Mr Peter Elston.
Sir, Recent movement in bond yields may be more rational than Gillian Tett suggests (“We have entered the world of disaster economics”, July 24). Nominal bond yields are essentially a function of inflation expectations, default risk and real interest rates.
Falling German and US nominal yields but rising credit default swap prices simply mean that real interest rates are falling faster than the default risk is rising, assuming long-term inflation expectations are stable, which they are. The governments in these two safe havens are stepping in to satisfy the excessive demand for savings that is driving real interest rates down by increasing bond issuance. But increased issuance naturally means higher default risk, as reflected in the CDS market. The danger comes when outstanding issuance increases to the point that default risk starts rising faster than real interest rates are falling. Assuming your safe haven status will be maintained is a little like passing a petrol station in the desert in the hope you’ll make it to the next one.
Peter Elston, Singapore
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