How does it compare to German, Japanese and Chinese yield curves?
On Friday, the 2-year US Treasury yield rose to 2.63% and the 10-year yield remained at 2.82%. This dampened the spread between them to just 19 basis points, the lowest level since August 2007.
This is another step in the "fluttering yield curve", which brings short-term and long-term yields closer together. If the 10-year yield does not rise on the rate hike and jumps, it could soon be lower than the 2-year yield – a condition called yield curve "inversion". This happens as the short-term rate hikes after the Fed's rate hikes rise to stir long-term returns. It looks like it's damn hard to do just that:
If the line in the above graph falls below zero and the 2-year yield is higher than the 10-year yield, the yield curve is "inverted." In the past, this condition was followed by recessions
The graph below shows the yield curves on December 14, 2016, when the Fed took a serious interest rate rise (blue line) and Friday, August 24 (red line). Note that the red line is "flattened" compared to the black line, especially the 2-year return. The 19-basis-point gap between the 2-year and 10-year markings is tiny compared to the 127 basis point spread on December 14, 2016:
What does this situation look like compared to the government bond markets in Japan, Germany and China?
When it comes to sovereign debt markets, the term "market" is a place where pricing takes place. Nowadays, the place is essentially a misnomer because there is no market in the sense that real pricing occurs at times Zero interest rate policy, negative interest rate policy and massive QE (Eurozone), Stealth QE (China) is taking place. and QQE (Japan).
Here are the yield curves of the US, Japan, Germany and China, with current yields in lighter colors and the returns of July 20 in washed-out colors:
Japan (dark blue line with red markings)
Annual yield at -0.11% and the 10-year yield at + 0.10%, the spread between them at 21 basis points – greater than the spread of the US Treasury! Japanese yields of 7 years and below are negative, but only slightly, and their yield curve end is flat. Note how the yield curve of the 10-year yield became steeper than the 20- and 30-year returns of 20 July rose (light blue line).
Japan's public debt is bloated, but the market has withered. Most of these securities are held by the Bank of Japan and state-controlled companies such as Post Bank and Government Pension and Investment Fund. There are days when not a single 10-year JGB is traded. So, forget the pricing. The BOJ performs the entire show.
BOJ's short-term interest rate target is -0.1%. In September 2016, Yield Curve Control was also introduced as part of the QQE bond purchase program. This directive directly manipulates the entire yield curve. The stated goal is to keep the 10-year yield close, but above 0%. What you see in the graphic above is what the BOJ wants.
Germany (green line with red marks)
The interest rate for the ECB's deposit facility is currently -0.4%. Its large-scale QE program pushed the entire yield curve down, and short-term returns were badly affected even by countries with fluctuating government budgets. German yields are negative for 7-year maturities, and the 8-year yield only marginally higher (0.11%).
The German yield curve remains unchanged at 3-year yields and increases steeply as yields become less negative slightly positive. With a 2-year return of -0.61% and a 10-year yield of + 0.35%, the spread between them is 96 basis points – more than four times the spread between US yields!
China (light blue line, blue marks)
The gap between China's 2-year yield (3.17%) and the 10-year yield (3.64%) is 47 basis points, down from 36 basis points on 20th of July. The yield curve has also steepened. Chinese government bonds play a relatively small role in China's gigantic debt bubble, which consists of bonds from other government entities, their off-balance-sheet vehicles, state-owned companies, and China's corporations in general, all of which are now massive and opaque, tangled tangles. This "hidden debt," as it is called, is the latest puzzle of the Chinese government to figure out how to quantify it at all, as it struggles to save everything from imploding.
In the US, where the Fed has been "gradual" since December 2015, a fluttering yield curve is part of the business. A reversal would be undesirable. But given the Fed's manipulation of the Fed market over the past decade, a reversal could no longer signal earlier inversions – and there have been discussions in this regard with the Fed.
But neither the ECB nor the Bank of Japan has raised their policy rates, leaving their respective yield curves unaffected by these effects. Both, however, have withdrawn from QE. The ECB will cease quantitative easing by the end of the year, and interest rate hikes will be on the menu for next year, which will undoubtedly trigger a firework of yield curves.
Five economists in the Fed's Board of Governors published research that encourages the IMF not to wait for inflation because, in the current dynamic, "exaggerated deviations in inflation from its target are a plausible outcome." Read … "Fed economists provide ammunition for the Hawkish approach of inflation."