Frankenstein Bonds Turning On Central Bank Creators

Tyler Durden's Photo
by Tyler Durden
Wednesday, Nov 03, 2021 - 06:30 AM

By Garfield Reynolds, Bloomberg Makets Live commentator and reporter

Central banks are facing a revolt from the once-lifeless bond markets they stitched together with quantitative easing -- one which threatens the longer-term outlook for growth and risk assets.

The short end of Australia’s bond market broke over the past week under the weight of the contradictions embedded in the central bank’s unprecedented stimulus settings. When the dust settled one of the developed world’s most-dovish major banks had been forced to tap out.

The RBA decided to abandon its stated policy of controlling 2024 bonds as liquidity in the securities evaporated and yields melted up.  Exacerbated by the conditions created by the central bank’s asset purchases, the bid-ask spread on the notes exploded to 20 basis points

The turmoil was reminiscent of the 1997 Asian crisis and 2008 Lehman Brothers saga, as Sean Keane, managing director of Triple T Consulting noted to me. The Australian market was “virtually untradeable” in the second half of last week, according to Keane, who headed up Credit Suisse’s Asia-Pacific rates desk from 1997 to 2008.

The angst wasn’t confined Down Under either. Yields jumped in October by the most in years across a number of key markets, though Australia did stand out. The table shows the moves in key markets in October, using three-year bonds in Australia and two-year notes for the rest.

Even as RBA Governor Lowe tried to sound dovish on the rates outlook he gained only limited traction and that highlights just how tough it will be for central banks to wrest back control of the narrative. The bond vigilantes are back, rising from their long sleep, and this time they are targeting complacent central banks instead of profligate politicians.

The key metric to watch now will be whether the recent global yield-curve flattening -- driven by inflation fears -- ends up unwinding to any sustained degree. A re-steepening would signal that central banks are threading the needle and persuading investors that tapering doesn’t mean a rush toward hiking rates.

Risk assets have looked nervous in recent weeks, for the most part just edging higher despite vaccination progress and earnings optimism. That underscores bond market worries about the fine line central bankers seem to be walking between two opposing potential policy errors.

If policy is too tight the global recovery from the pandemic will subside, too loose and inflation will break out. Both put risk assets under threat.