The standard explanation for low bond yields has been driven by – who else? – Ben Bernanke summing up the view from econometrics. Term premiums, he says, these made-up decomposition components which only allow for QE to save a tiny bit of its face. In other words, QE obviously didn’t lead to recovery, it sure didn’t create modest let alone overheated inflation, and only the most favorable studies can find a rather underwhelming contribution to lower interest rates (because the market does the vast majority of the lowering, if not all of it).
What’s left by which to claim some minimum of success if you’re a QE practitioner? Bernanke in 2015:
What about the decline in longer-term yields since early 2014? In the US at least, that decline is somewhat surprising, as economic fundamentals have recently seemed more consistent with rising, not falling, longer-term yields… By the process of elimination, with fundamentals stable or improving, much of the decline in yields over the past year must reflect a sharp drop in term premiums. [emphasis added]
That’s the thing about term premiums; they’re entirely fictional, the remainder after statistical models attempt to dissect interest rates into a couple of parts. What if those decompositions aren’t the whole story?
The problem for Bernanke, as Yellen and the whole mainstream, in 2015 (and again in 2018) was that it seemed like all the negative fuss was deposited somewhere else than the US (“overseas turmoil”, as it was called back then).
For bond yields, then, it would seem sensitivity to fundamentals not exclusively domestic. Term premiums or not, lower yields were reflecting global setbacks and the rising probabilities of more and worse ones. Maybe the US wouldn’t fare as badly (it didn’t, but it wasn’t unscathed, either) but that’s not what drove UST yields then nor would it be in them now.
Global economy and the global money which drives it (repeatedly into the ditch).
Economists, however, approach this very differently – which is a kind way of saying wholly incorrect for all the wrong reasons. They think the domestic US economy is a largely a closed system, therefore UST yields reflect only those factors and from that they break down Treasury yields.
They have to do it this way otherwise their DSGE models would be made worthless (they are worthless, but by fooling themselves they can pretend R* or something). I wrote in August 2019 when many of them were quick to dismiss the UST curve inversion as anything other than what it had been:
Term premiums are not science nor really math. They are made up and more than that they are rationalizations, truly Orwellian, intended to deny the obvious and straightforward signals coming from the very fundamental building blocks of all finance and economy. The entire notion is purposefully shrouded in unnecessarily complex concepts whose only true use is to attempt to answer for the otherwise inexcusable.
As I often write, Economists don’t understand bonds. But they know just enough of them to understand that they had better change the subject.
The problem – for the econometricians – is that the evidence has been utterly conclusive and it’s been this way for a long time. Even before Ben Bernanke’s attempt to save QE via term premiums six years ago, the truth was open and obvious right from the beginning; global economy and global money (how else does the entire world simultaneously experience liquidations, otherwise known as a Global Financial Crisis?)
You can see why Bernanke would be so desperate for term premiums to add up.
Evidence being stubborn, however, even some Fed staff are starting to catch up (thanks T. Tateo). It may take them a few decades too long, but here comes another small dose of badly needed science and common sense:
But because the term premia are obtained as a residual component in the model, any misspecification of the factor structure that drives equilibrium interest rates—by omitting a common global factor, for example—may result in erroneously attributing some fundamental movements to the term premia.
Yes, typical technical gobbledygook. So, let’s back up first: what this Atlanta Fed Economist is saying is that by recognizing how global bond yields often (read: always) act in concert (UST’s like German bunds or JGB’s), it’s beyond incompetent to ignore how and why this must be. To immediately propose term premiums is to run an incomplete calculation. Or:
This observation raises the possibility that domestic bond yields, including those in the large U.S. Treasury market, may be anchored by global economic developments, provision of global liquidity, and international markets arbitrage.
Because of these things, closed-system Economists like Bernanke are not, in fact, eliminating all the processes which might explain yield movements before zooming in on the otherwise improper remainder which is the made-up term premiums. Had Bernanke the scientific sense to be open about this, he’d have seen – and calculated – a global money and economy factor which would’ve worked out to a completely different understanding.
Low rates were not a good sign as Bernanke had claimed by yielding wrong term premium remainders, they had always been an unqualified and ultimately correct challenge to the orthodoxy’s evidence-free insistence QE had created something positively tangible.
Now, this week, Warren Buffett says the US economy is “red hot” and that inflation is barely contained ready to break out. All due respect, the Treasury market has no idea what the Oracle of Omaha is even talking about. The goods economy in the US might be red hot, but what about everything else? In the closed economy approach, there is nothing else to consider.
UST yields might also be pricing something very different than inflationary overheating out there for the rest of the world. And, as we’ve seen time and again, ignoring all that will lead you to these same inflationary mistakes.
Here you can see what I mean using a single American data series: trade.
By some accounts, Uncle Sam has juiced domestic demand and then some. On the one hand, low bond yields recognize the “transitory” nature of such juice while on the other surveying the rest of the economic scene beyond the US border into every corner into which the eurodollar system heavily influences (meaning everywhere) it doesn’t look nearly so hot. In many places, downright frozen while in others (ahem, China) what was only ever lukewarm cools again by the monthly data release.
US goods may be gangbusters (and even that’s overstating it; imports a bit higher than 2018 peak isn’t really that impressive, it is only relative to everything else), but what must be truly happening everywhere else (including domestically in services)? We don’t have to wait for an answer; it’s right there in low bond yields even if Warren Buffett hasn’t figured it out yet.
And on that account, inflation isn’t the primary risk. It can’t be.
As I wrote last week, comparing and tying Chinese industrial sentiment to tame American inflation estimates, it’s the same thing as the Atlanta Fed guy above is finally catching up to:
It’s not that we here in America need China’s economy over there to become truly robust in order to create inflation on this side of the Pacific; it’s that if the Chinese system ever does achieve something like that we could then sincerely propose how global conditions must have changed sufficiently such that we might finally see inflation as recovery confirmation here and everywhere else.
Unless we start to honestly see globally synchronized growth then this is what we get; it’s all we’ve gotten from August 2007 onward. From tame US inflation to frankly concerning Chinese data points, why aren’t bond yields moved much at all.
Baby steps. Though it will take years or longer for this to trickle into the mainstream, you shouldn’t deny the mountains of evidence which strikes down one myth after another: Bernanke’s global savings glut debunked; QE actually starves liquidity in collateral; a worldwide connection of monetary conditions and their economic consequences via safe assets. Officials and Economists are groping along the contours of the eurodollar because, those like Bernanke, have been driven by ideology not evidence.
Term premiums never were, as some are starting to heed the proof. It’s the global in globally synchronized, and it has been for more than half a century. Welcome to the party. The reason the festivities remain so pitiful are the throngs of late official arrivals.