The world seems to have shifted. Maybe the West…the United States, Great Britain, and Europe…are not the "safe havens" that they once were.
Just look at the front-page headlines on the Wall Street Journal today: "Foreigners Dump Debt."
Not a very encouraging headline.
I have argued for several years that the risk-averse monies flowing into the United States from elsewhere in the world was skewing longer-term US interest rates to the low side and this was showing up especially in the yield on the US Treasury's Inflation Protected securities (TIPs).
In the current period of economic recovery, the yield on TIPs dropped below one percent in the fall of 2009, just after the US expansion began in July, and proceeded to go lower dipping into negative territory in the fall of 2010.
More specifically, the yield on the 5-year TIPs dropped below one percent in early September 2009 and dropped below zero-percent in late September 2010. The yield did not return to positive territory until September 2014.
The yield on the 10-year TIPs first fell below one percent in September 2010 and only dropped below zero-percent in October 2011. This yield rose above zero-percent in June of 2013.
The drop in these yields to such low levels was connected with financial problems, primarily in Europe, but also financial concerns elsewhere in the world.
After moving back into positive territory for a time, we find the yield on the 5-year TIPs dropping below zero-percent in early March of this year and have remained there ever since.
The yield on the 10-year TIPs dropped below zero-percent for a few days in early July and this movement was associated with the vote in Great Britain to leave the European Union…Brexit.
It dropped below zero again in late September…again associated with disruptions elsewhere in the world.
But, then a funny thing happened as the year was beginning to end up. Donald Trump surprised almost everyone, not only in the United States…but also in the world…by winning the battle for the United States presidency. And, things started to change.
In October, the yield on the 5-year TIPs averaged around -40 basis points and the yield on the 10-year TIPs averaged around + 7 basis points.
The week after the presidential election in November, the yield on the 5-year TIPs jumped to around -15 basis points and the yield on the 10-year TIPs rose to 36 basis points.
By the middle of December the yield on the 5-year was in positive territory and the yield on the 10-year was 70 basis points. Now, the two yields are around -15 basis points and 40 basis points, respectively.
What's going on here?
According to the Wall Street Journal article "Foreign buyers, led by China, are taking a smaller slice of the debt issued by the US and other major economies…."
"For much of this century, the world's money increasingly sought the harbors of the bond markets of big, Western nations, principally the US, but also Germany and Britain….
"Foreigners are steadily pulling back: As of November, for the first time since 2009, less than 30 percent of the $20 trillion market for US government debt was held overseas, according to the latest official data, released in January, from the Treasury Department and Federal Reserve. In the U.K., it is now 27 percent, compared with a record of 36 percent in 2008. In Germany, it is 49 percent, down from a peak of 57 percent in 2014."
All of a sudden there seems to be major reversals of money flows in the world. These have followed the Brexit event in June, the election of President Trump in November, and the increasing worry that the current chancellor of Germany, Angela Merkel, might have difficulty in getting re-elected this year due to populist movements in the country. And, there is the ever-increasing concern about what might happen in the elections in France this year, a possible election in Italy, and one in the Netherlands.
In other words, perhaps the "safe-havens" of the world are not such "safe-havens" any more.
So, does this mean rising longer-term interest rates?
Well, analysts certainly argued that the historically low longer-term interest rates of the current economic recovery could be explained to a large extent by the flow of this risk-averse money into the "safe-havens" of the US, the UK, and of Germany…along with the Fed's quantitative easing…and the quantitative easing of the European Central Bank.
Now, we are on the other side of the mountain and one could certainly argue that if the money continues to leave the "safe-havens" than the yields on TIPs should rise back toward more "normal" levels.
Historically, the more "normal" level for both the 5-year and the 10-year TIPs is around 2.00 percent or modestly above.
The argument I have made over the past several years is that the US, at some time in the future, could lose these risk-averse funds. If so, then one can expect that the yields on the TIPs will rise and the yields on regular Treasury issues will rise.
Given that inflationary expectations are around 2.00 percent right now, even if the yield on the 10-year TIPs were to rise to 1.25 percent or to 1.50 percent, that would put the yield on 10-year Treasuries in the 3.25 percent to 3.50 percent range.
This is something we need to watch carefully.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.