Pro Perspectives 6/16/23

June 16, 2023

Yesterday we talked about the era of explicit central bank market manipulation.  
They crossed the line in the sand, during the throes of the Global Financial Crisis, and unsurprisingly, they haven't looked back.
The Fed has now "normalized" interest rates, taking the Fed Funds rate to 5%-5.25%.  And yet the 10-year yield is just 3.7%. 
The UK has taken rates from 0.10% to 4.5%, still undershooting a hot 8.7% inflation rate, and yet the yield on the 10-year UK government bond is just 4.4%.
The European Central Bank has taken rates from negative 50 basis points to 3.5%, while inflation is running over 6%.  And yet the German 10-year yield is under 2.5%.
Are these very tame government borrowing rates, the product of a "smart" bond market pricing in a (high) probability of recession? 
Or are these very tame government borrowing rates, the product of governments intervening to fix market interest rates at a level they can afford, and thereby avoiding ballooning interest costs, a global credit crunch and sovereign debt defaults?
It's the latter (i.e. manipulation).  And they've made little effort to hide it.   
Early in the "rate normalization" phase, both the Bank of England (BOE) and the European Central Bank (ECB) had to rescue their respective government bond markets. 
The ECB had to step in and promise to be the buyer of last resort in the big fiscally vulnerable constituents of the euro zone (namely, Italy and Spain).   In the same month, they ended QE and restarted it (by a new name), by guaranteeing to keep the bond markets stable.   
Then the Bank of England was forced to step in, after a doubling of UK government bond yields, in a little more than a month.  A self-reinforcing debt spiral was underway. 
As for the Fed, the Kryptonite of 4%+ 10-year U.S. government bond yields coincided with 1) the collapse of the biggest crypto exchange, and then 2) the banking system shock.
Both have resolved in a return of the world's benchmark interest back to the comfort zone (of 3%-4%).   
As we discussed yesterday, coordination with the Bank of Japan (who continues to print money and buy assets) is good way to keep this important global interest rate (the U.S. 10-year yield) out of the danger zone.  
Not only does keeping this anchor rate in check go a long way toward keeping global sovereign debt markets solvent, but it keeps consumer rates (most of which are derived from the 10-year yield) affordable (promoting economic activity).  
So, as we discussed yesterday, many continue to point to inverted yield curves as signals of a looming recession.  But that ignores the central bank manipulation, which is promoting the opposite – stability and economic activity.  
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