Why U.S. Treasurys Look Like High-Yield Bonds

Transcription

1 Boom & Bust Monthly Insight Video September 2014 Why U.S. Treasurys Look Like High-Yield Bonds Hi, I m Rodney Johnson. Welcome to the September 2014 educational video. This month we re going to talk about U.S. Treasury Bonds, and more specifically, the yield on U.S. Treasury Bonds and the yield on the 10-year bond. It s sitting at about 2.5%. You may not think about it this way, but if you look at the United States and then through the euro zone, we re actually the high yield offering, meaning we ve got one of the highest yields out there, which you normally associate with people that are a bad credit risk. But it s not about that at all. Now when you look at the U.S. Treasury yield on the 10-year going back to 2009, like this chart does

2 you see that it goes up and it s between 3.5% and 4%, then it falls. Up a little bit. This has to do with QE back and forth, because when the Fed s buying bonds, of course, the yield comes down some. It dropped dramatically last year, and it was actually under 2% between 2012 and 13, went back up earlier this year, and now has fallen again. So it s been kind of a back and forth. But like I say, currently it s around2.5%. Now when you jump across the pond, look at what s going on in France and Germany. The French 10-year government bond is just under 1.5%; maybe 1.3%, 1.4%. The German 10-year bond is under 1%. 1%! You don t even get 1% for investing for 10 years, if you actually held it to maturity. Now this is a little strange. Yes, they have very low inflation and thinking about deflation, and yes, their growth is not really growing. The Germans are doing okay, kind-of, barely, but the French aren t. They actually have unemployment over10%. So why would this be? Well, look a little bit further and you ll see that it s not just the strong ones. These are the PIIGS

3 This is Portugal, and Italy, and Ireland, and Greece, and Spain, and you ll see the one in the middle, of course, is Greece, that shot up dramatically during basically their default when they crammed everybody down back in 2012 and 13. But then it fell, and they re all coalescing under5%. As a matter of fact, they re all pretty close to the United States at about2.5%. Greece is the one outlier. If you look, it s right about5%. How could we be in the same straights as Portugal and Spain? Well we re not. It has to do with something outside of just looking at the quality of the bond in and of itself. It has to do with excess reserves. Now this chart shows the excess reserves held at the European Central Bank by European banks

4 and it was fairly flat until 2012, and then it shoots up dramatically. There was a loan program that happened, and then the bank started repaying the loans and their excess reserves came down. But they still had a lot. They still had over 100 billion euros sitting there. Well the European Central Bank didn t want that there. They wanted them to get the money out. But they can t just close the doors. So what they did was they made it punitive for them to hold bonds in excess reserves, or hold money in excess reserves at the Central Bank. And the way they did that was by changing their deposit rate. Now this is the deposit rate for excess reserves at the Federal Reserve, which is in blue, as well as the European Central Bank, which is in red.

5 And you will notice that they both start a little higher, around 1% for us or just under, and really up at 3% for the European Central Bank. They both go to a 0.25% there in late 2008, and then they flat line. Now, the Europeans moved theirs up a little bit for a short time in late 2010, but then it came back down again, matched us for a while, and then the European Central Bank dropped theirs to zero in late Stayed there for years, and it has recently dropped below zero. Starting in July of this year they start charging European banks to hold money at the Central Bank. Very odd. They charged them 10 basis points. Recently, they changed it to where they charge them 20 basis points. They charged them even more for holding excess reserves at the Central Bank. The message here is clear. The European Central Bank is saying get your money out because they want these banks to go lend to consumers and businesses and have it gin up the economies of the countries in the euro zone. But the banks have a different goal. They actually want to keep their money. They don t want to pay a penalty, but they also don t want to lose it making a loan that might not pay off. So what do they do? They turn around and they buy bonds that are issued in euros, which would be the government bonds of France, and Germany, and Portugal, and Spain, and Italy, and all those other countries. And so what they re doing is driving down the yields on those bonds for a very unrelated reason.

6 Doesn t mean anybody thinks Spain is great. Nobody thinks Portugal is doing wonders. What they do think is they want to get their money back and they don t want to pay a penalty. So they take it out of the ECB and they buy these bonds, which of course pushes down their yield, which makes us look like the high yield offering. Very strange. This is the same thing that can happen in the United States if the Federal Reserve was moving around the interest rate on deposits here. We don t think that s going to happen any time soon. The Fed uses that as a gate in the other direction. They keep that interest rate at 25 basis points, like you see on the chart, so that money doesn t flow into the economy. That s how they re keeping a lid on the $3.5, $4 trillion in excess reserves that they re sitting on. Thank you.