"Tapering" From Currency-Wars To Interest-Rate-Wars

Tyler Durden's picture

"The opposite of currency wars is not necessarily currency peace; it can easily be interest rate wars," is the warning Citi's Steve Englander sends in a note toda, as EM and DM bond yields have relatively exploded in recent weeks. The backing up of yields represents an increase in risk premium, so this will likely have negative effects on asset markets and the wealth effect abroad as well. It is difficult to explain the magnitude of the yield backup in terms of normal substitution effects, and broadly speaking, if you were to compare the backing up of bond yields with the beta of the underlying economy and asset markets there would be a good correspondence. So, Englander adds, it is fear, not optimism that is driving bond markets.

Via Steven Englander,

The opposite of currency wars is not necessarily currency peace; it can easily be interest  rate wars.  Since May 1 the median increase in 10year local bond yields in 47 major EM and developed markets (DM)  is 39bps. Among major EM economies (light blue) it  is 83bps; among major DM (dark blue) economies it is 29bps. The US 10year Treasury yield increase (red)is only at the median of developed economies and well below the overall median. In both EM and developed economies, the fat tail of rate increases is to the upside, so average increases are even higher. The paradox is that the run-up in US interest rates, which is arguably the primary driver of these global rate increases, is well below  the average and median globally.




Even if we assume that the GDP-weighted average increase in yields is about 30bps, it represents a significant tightening in global economic conditions. The inflation picture has not changed materially in the last six weeks; if anything, it may be more benign than earlier thought. On a global level, exchange rates cancel out and do not affect the effective stance of monetary conditions to a good first order approximation. We may argue that the US rates increase is justified by the improved US economic outlook, and some will debate even that.


However, the US represents about 20% of global GDP, and outside the US there have been very few calls for monetary policy tightening. As a consequence roughly 80% of the world has experienced a monetary policy tightening that was neither expected nor desired.


There is a rule of thumb  that 100bps of tightening at the short end translated into 20-30bps of tightening at the long end. If we invert that rule and use 30bps as the global average monetary tightening at the long end, then we have experienced the equivalent of 90-150bps of monetary tightening at the short end. If, given the skew, the effective increase at the long is closer to 40bps, we are looking at the equivalent of 120-200bps of short-end tightening. That is a lot, given that EM has been underperforming all year, and euro zone, japan and UK growth on the whole are not registering major upward surprises.


The backing up of yields represents an increase in risk premium, so this will likely have negative effects on asset markets and the wealth effect abroad as well. It is difficult to explain the magnitude of the yield backup in terms of normal substitution effects, and broadly speaking, if you were to compare the backing up of bond yields with the beta of the underlying economy and asset markets there would be a good correspondence. So it is fear, not optimism that is driving bond markets.


This backing up of yields is spilling over into exchange rates, although the correspondence is less than 1-1. In Figure 2 countries are ordered by the magnitude of their depreciation. By and large countries with bigger depreciations have experienced bigger increased in bond yields, although India and Australia stand out as exceptions on one end, and Hungary on the other. The backing up of yields in the euro zone periphery at some point may become a problem, as this adds to growth headwinds. The fact that this backing up is driven by global forces, not sovereign risk concerns does not make it less negative.



It is tempting to say that DM and EM countries facing bond market pressure should just ease monetary policy further and take the hit on the exchange rate, so that effective monetary conditions are eased. Easing in response to the US-bond-market-induced monetary tightening is not feasible for many central banks. The ECB sees itself as having limited policy room now. The impact of BoJ’s easing has been undermined tremendously by the backing up of risk premia and implied volatility, and consequent softening of asset markets. EM is constrained in easing 1) because inflation may respond much quicker than output growth to a significant depreciation, and 2) there is some evidence that depreciations are now translating into further pressure on bond markets, undermining the effectiveness of ease. So bond wars may not be any more pleasant than currency wars.


The upshot is that we may continue to see pressure on commodity and EM currencies until asset market conditions stabilize. We continue to distinguish between higher levels of rates and higher levels of rate and asset market volatility. If US bond markets were to stabilize at current or even higher levels, but be accompanied by lower volatility, then other countries may be able to introduce offsetting macro policies. However, as long as the backing up of bond yields is accompanied by the higher volatility in asset markets, they are likely to find their policy options very constrained, and their asset markets under continuing pressure.

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lasvegaspersona's picture

Beyond my ability to understand...

ACP's picture

It's actually pretty easy...


maxmad's picture

 Easing in response to the US-bond-market-induced monetary tightening is not feasible for many central banks.


Who would have known that printing money wasn't the answer?

delivered's picture

I would tend to agree as the author of this article needs to spell out the conclusions a little clearer. However, my take on the current situation is fairly simple as follows. Historically and with normal economic expansions and contractions, interest rates tend to rise in the second half of an economic expansion as growth gets a little too hot, inflation perks up, and thus, interest rates rise in order to cool these items and assist with the efficient deployment of capital. 

However in the current market, this is really not present as growth is weak at best and in a number of regions including Europe, a recession is present. Further, inflation (as we've been told countless times) is not a problem either. So it would appear that while the recent initial action in the bond markets is due to the potential of the FED tapering, I believe the bigger picture simply indicates that the credit markets are finally waking up to the fact that "rates" are now being driven by core credit conditions. That is, the supply and demand of debt with supply outstripping demand (primarily soverign) combined with the realization that the quality of debt is worse than most people understand or want to believe (i.e., no worthwhile collateral, no cash flow to support the debt, and the only form of secondary repayment of the debt, that is CB's, reaching the end). 

So debt may finally be getting to the point having to be priced at actual market rates (heaven forbid) as oppossed to CB intervention pricing. Where this ends up, well I couldn't tell you but let's face it, all western country soverign debt is priced way too low with surpressed interest rates. It's one thing if the CB's lose control of the equity markets but it's something entirely different, if the debt markets and interest rates spin out of control as there will basically be nobody left to buy the debt coming on the market (if the CB's curtail their efforts). 

For the US, a decade ago SS had a yearly surplus (and was a net buyer of treasuries). The federal deficit was managable at $300 billion a year. Foreign buyers were plentiful and willing to recycle USDs into treasuries (specifically China fueling growth). So the debt markets were well supported and stable (but ironically, at higher interest rates). Today, SS is running a deficit and a net seller of treasuries. The federal deficit is averaging $1 trillion per year. Foreign buyers have either curtailed purchases or are looking to reduce holdings (e.g., China buying assets in Africa with treasuries). The only buyer left in town were the CBs (either directly or indirectly) so with this support gone, there is no question the market is in uncharted territory. 

Not sure if the FED will let the rates increase too much before stepping back in but even if they do, it will represent a short-term solution only. At this point, the FED is damned if they do and damned if they don't but it's clear that if they lose control of the debt/rate markets, the impact on all asset values will be one for the record books.

disabledvet's picture

"the only solution is to monetize." in plain English: "paint yourself into a corner." this is an IDIOM. "i started painting the floor but i was so productive and efficient and painted myself into a corner and HAD TO WAIT FOR THE PAINT TO DRY (ink?) before i could free myself." the Fed...and all other Central Banks are going on a global printing spree "with Governments racing towards confiscation"? savings as just the beginning? private property? gold? oil and natural gas still looks good to me because they're generating massive amounts of economic activity. the Fed "in the meantime" has been pondering its "exit strategy" for some time now. not easy when you perceive asset inflations "beyond all reason" all over the place. the Fed's problem is "one of success." they've "done so well" (by Wall Street standards) they risk doing exactly what happened in 2008 "by doing anything." again "we must wait" but clearly something has changed and changed significantly.

buzzsaw99's picture

...it is fear, not optimism that is driving bond markets

Bull fucking shit. There are no markets. "They" are trying to scare everyone out of bonds and into stocks so "they" can double fuck them (again). Rates are going nowhere but down over the long haul. Pure desperation play with lies galore to start a panic out of bonds and into stocks. What kind of dumb fuck panics and sells bonds only to flee into the stock "market"? hahahahahah http://www.youtube.com/watch?v=pC_XT-HdBvE

fonzannoon's picture

""They" are trying to scare everyone out of bonds and into stocks so "they" can double fuck them (again).

That sounds like the plan although having stocks drop while rates are rising ain't gonna close the deal on the stupid rotation.

Maybe "they" are going to "double fuck them" by having been positioned short bonds and short stocks already and are now just enjoying the show. When everyone goes to cash they will float the NAV's and send them back running into the fire.

buzzsaw99's picture

Probably so, but as for the notion that interest rates are going sky high and staying there, pure fallacy.

disabledvet's picture

you could get a rotation where "the wheel is spinning so fast everyone flies off the thing." i mean give me a break...rotating out of treasuries and into equities? THEY'RE UP OVER 140% FROM THE PANIC LOWS ON THE AVERAGE. your gonna get a friggin' rotation all right...INTO "the lessons of what risk is in the first place." what do they call it now? a "bail in"? when "they steal depositor money" but only "in excess of 100,000"? http://www.youtube.com/watch?v=IWaLu6-YlTo

tradewithdave's picture

Introducing the sovereign version of debt for equity swaps. On a two dimensional spreadsheet the "zero lower bound" appears boxed in but in a triple entry accounting framework the fun (and the means testing) is just beginning. Sagan's "flat landers" meet Volcker.

Dr. Engali's picture

They aren't going to. That's why the bond market will eventually blow up. Look at what happened to the dividend players once the ten year hit 2.23.... they sold off hard and money went into the ten year. That's the Bernank's goal. To get enough fear in "the market" and help pick up some of the bond buying slack.

buzzsaw99's picture

You are on the right track imo. My thinking is that he knows the exact number he wants for the S&P. It is a little too high right now so gonna scare it down a bit but not too much. Pure manipulation 24/7. All puppeteers, all the time. Goldilocks reCONoME rides again. [/cliche]

fonzannoon's picture

That is why today was so interesting Doc. The market sold off and treasuries sold off as well. I can't imagine that continues, but it was weird.

I know I differ than most on here, but I think there is a comfort level somewhere in the 2.25 - 2,5% range. Stocks may get beat up a bit on the way there. But that seems where it wants to go. I have no doubt, like you and buzz seem to agree, that if rates go outside that comfort level something will come along and smash stocks to pieces and send yields down.

Dr. Engali's picture

Yeah you're probably right there. 2.5 is still manageable right now and it gives them some room to maneuver in the markets. IMO the Bernank was trying to take some of the bubbliness out of the stock and junk bond market.

Wm the Shrubber's picture

Both equities and bonds are selling off as leveraged players are winding down excess margin.  No cash is generated to redeploy; deleveraging is the net effect.  This can continue to some time, but like you I would expect that at the 2.5% level you will see more traditional dynamics with falling equities providing a bit to bonds.  When the Fed has destroyed all valuation metrics, combined with obscene leverage, markets can/will do all sorts of fucked up things!

SamAdams's picture

Rising rates will kill stocks.  Banks bought stocks to appear solvent as the djia inflates.  If banks do not exchange stocks for bonds during rate rise, derivative implosion will follow.  Are banks selling stocks? So, either print more money and kill the dollar, or raise interest rates and total the banks and economy.  Being that bankers appear to run the USA, which path do you think will be taken?  

Herd Redirection Committee's picture

Exactly, its a choice between the currency or the status quo/government (the banks).   The scary thing is, I think the final desperate act will be 'letting' interest rates rise 'a bit' (which might be already happening), which then in turns spirals out of control, stock market gets smashed, house prices slammed, people withdrawing their money from the bank, so banks have to pay interest on deposits... Banks start lending, the loans chase everything that isn't nailed down... Inflation... Loss of reserve currency status...

Nue's picture

Investors are so damn desperate they're looking for Yield on Craigs list.

maxmad's picture

Craigslist and Monsato for higher yields...

Dr. Engali's picture

Once again, we don't have investors we have a nation of renters. An investor puts money to work in an idea that they believe will pay off later on down the road. They understand that they may lose their investment. Renters on the other hand expect a return on their money no matter what regardless of risk.

zorba THE GREEK's picture

Fear is the great motivator.....Fear of missing out, fear of being out-performed by your peers,

fear of being seen as a whimp......but the fear we should all embrace, fear of losing all our money,

should be #1 but is low on the list. Buy physical PMs and fear not.

Cosmicserpent's picture

Rising rates are basically an institutional margin call. Where's my collateral bitchez! This is leading to all sorts of carry trades unwinding and should cause commodity speculators to have less leverage.  Could be an awesome feedback loop. Gold is gonna take it up the ass. (In the short term).

q99x2's picture

Everything is converging to the dot from which reality was born. Coming home to mama. Yeeeeeehaaaaaaa.

EclecticParrot's picture

"The fact that this backing up is driven by global forces, not sovereign risk concerns does not make it less negative."

I suspect in some ways it might make it more negative, as there are fewer temporary fixes via finance minister agreements and empty promises, instead it's more in the hands of traders, ahem, I mean self-interested investors.

Reminds me of trying to edit a photo in the full version of PhotoShop:  first you click the little wand, then you draw a little curve, then click and something disappears, then you make so many contrast and gradient adjustments, you can't get back to where you were, which wasn't ideal, but was better than the Kadinsky painting you've somehow made of your nephew's graduation photo.

Herd Redirection Committee's picture

So in this example what do Photoshop's layers correspond to?

The different classes in society?  The 1%, untouched by your messy editing, riding high and dry?

EclecticParrot's picture

Possibly, or it could be that every global financial center has it's own hidden layer they're selfishly fucking with independently, yet they believe the overall picture, when combined with the others, could make even Raphael jealous.

douglas's picture

If we maintain these two facts in perspective...

1. The Fed and most Western central banks exist to empower the elite and the banking system not the people or their currency.

2. In the end the Market will always have the last say.

... Then this is realy not that complicated.  Since 2008, the bank bailouts and monetary easing have brought about the illusion of a recovery.  The cheap money (ZIRP) at the expense of savers has permited the re-inflating of the stock market by mostly institutional investors.   In the meantime the never ending money printing has allowed the Fed to purchase the treasury bonds no longer wanted by other entities (principally China), thereby maintaing interest rates artificially low.  The desperate search for a decent return on their investments has recently led many private investors to risk their remaining assets in the wall street casino even knowing that it is rigged.

So what has changed? Why after all this time have interest rates been moving up lately?  Bad news for the US, but China is now not only not buying T-bills - they are in fact begining to spend them (most notably in Africa).  The 85 Billion per month is no longer enough (I suspect that rather than tapering we are soon to see an increase to aprox 110 Billion).  Combine this with a falling dollar, worries about the ever increasing debt and the deteriorating situation in the Middle East - and one can only wonder how the Bernank has maintained the curtain over the sheeple´s eyes drawn for so long.  I  have no doubt that the Fed wil do whatever it takes if interest rates on treasuries get near 2.5% - they have to because allowing rates to increase in any significant manner would make the servicing of the debt (currently 130 billion) completely unmanageable.

In the end it matters not for in the end the market WILL have the final say.  In the meantime two options remain, neither one ends well and both are beyond the scope of this brief - (1) WAR & (2) Currency devaluation.  Phisical Precious metals (preferebly out of your countries jurisdiction) is now more than ever a necesary choice.  God help us all...


tradewithdave's picture

What market? Seriously... what market? Toner cartridges? Point to a market. I forgot what one looks like. Dr. Pippa's onions in India? Okay... the onion/gold pair trade at the bazaar. Now give me another... tick, tick...