The past week has seen major increases in global interest rates. This would be good news if it was due to a strong global economic recovery. But it isn’t. Yesterday, Q1 US GDP growth was revised down to 1.8%, for example. Instead, it seems to reflect investors’ fear that central banks may be losing control of the market.
The chart highlights the change that has taken place, using the concept of the JUUGS (Japan, US, UK, Germany, Switzerland) versus the PIIGS (Portugal, Ireland, Italy, Greece, Spain):
- The blog first presented this 2 years ago, to argue that analysts were entirely wrong to worry about renewed inflation. Ageing western and Chinese populations are a replacement economy, so there is little risk of a demand surge which would lead to serious inflation
- As a result, the real issue is about return of capital, versus return on capital. Older investors (who control 75% of investable assets in the West), have less time to recoup lost capital, as they need it for retirement. So return of capital is their key concern
- Thus interest rates had been falling in the JUUGS from August 2010 (red column) to May 2013 (blue). These were seen as ‘safe’ markets.
- They had instead been rising in the 3 main JUUGS (Greece/Ireland were supported by the ECB after their defaults)
But now investors are starting to worry that central bank bond buying via their $10tn liquidity programmes has pushed the JUUGS into a more risky position. Their rates today (green) are higher – for the first time since August 2010.
Clearly we don’t know what will happen next. Investors may decide their fears were over-stated. But they may decide to worry that China may begin to sell its $1.2tn holding of US Treasury bonds and $450bn of US housing agency bonds? Or Japan its $1.1tn of Treasury bonds?:
- There is no reason for either country to continue to own these bonds
- They loaned the money to support their export sales, so Americans could buy their goods
- But their exports today have slowed, and they need the money to support their own economies
Central banks have gambled huge amounts of money on the risky and unlikely proposition that they can kick-start growth. They preferred to ignore the obvious fact that ageing populations cause growth to slow or go negative. Current interest rate moves highlight that this risk is now becoming more obvious, and on a wider scale.
8 July update. Blog readers read it here first. Official data today shows Japanese investors were selling $29bn of foreign debt in June, as this post was being published. This was a record amount according to the Ministry of Finance