Central bankers like the Bank of England and US Federal Reserve cannot race to the rescue because they’re the ones to blame for the awful mess we find ourselves in. Now it looks like we’re finally set to pick up the tab for two decades of ultra-loose monetary policy, and it’s going to be massive.
Most people do not understand how the global bond market works, yet it is bigger and more important than the stock market.
Governments and companies issue bonds to fund their spending, and these are traded on the bond market. At last count it totalled $126.9trillion, marginally bigger than the global equity market.
Yet private investors pay it little attention, because in normal times the stock market is where all the action is.
As I explained recently, these are not normal times for the bond market, and thanks to central banker tinkering it’s going to get even crazier.
Ever since the dot-com crash in 2000, the Bank of England, Federal Reserve, European Central Bank and others have slashed interest rates every time the economy wobbled or stock markets crashed.
After the financial crisis in 2009, they slashed rates almost to zero and unleashed a new policy know as quantitative easing, or QE.
This involved flooding the market with bonds, to drive down interest rates. Central bankers then bought back those same bonds, paid for with virtual money.
The BoE alone bought £895billion worth of bonds but that is a pittance compared to the Fed’s $6trillion splurge.
When Covid struck, central bankers flooded the market with yet more newly minted money. President Joe Biden is now pumping another $1trillion into the US economy as part of his weirdly named Inflation Reduction Act, aimed to boost clean energy.
All this stimulus has triggered today’s inflationary storm and forced central bankers to reverse course. They’re now tightening monetary policy instead of easing.
And it’s going to hurt.
As mortgage borrowers know to their cost, the BoE and Fed have been hiking interest rates again and again.
They have also started to unwind QE by selling bonds rather than buying them, a process known as quantitive tightening, or QT.
There’s a problem.
The market is now flooded with bonds. Supply is outstripping demand and buyers are demanding higher interest rates as a result.
Yields on 10-year US government bonds, known as Treasuries, have now shot up to 4.80 percent, the highest rate in 16 years. Two-year Treasuries now yield more than five percent.
While bond yields soar, prices crash.
That’s also bad news for stock markets, too. Why take a punt on shares when you can get five or six percent a year from bonds, without putting your capital at risk?
It goes without saying that higher rates are bad news for borrowers, too.
Central bankers kept interest rates too low for too long, and now they’re going to keep them higher for far too long as a result.
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The US economy is still running red hot, as confirmed by yesterday’s figures, which showed 336,000 new jobs were created in September, way above the estimated 170,000, according to the US Bureau of Labor Statistics.
This will drive US wages even higher, further stoking inflation. So the Fed will have to hike rates as high as seven percent, upping the pressure on the stock market.
Analysts now reckon that stock market will have to crash, in order to make shares cheap enough for investors to buy them again.
It may already have started, with Wall Street falling six percent in September.
A stock market meltdown will be a disaster for existing pension and stocks and shares Isa holders, who will see the value of their holdings fall.
Worse, there is little prospect of a quick recovery, as interest rates may stay high all the way through 2024.
Higher bond yields will also increase the risk of a recession, as additional borrowing costs weigh on the economy.
Central bankers are totally helpless. They created this problem by slashing interest and now have no choice but to hike them despite the collateral damage.
Now we are all about to suffer as a result.
