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‘Higher Bond Yields Without Better Growth Can Quickly Become Self-Defeating’, Goldman Warns

It's still too early for a sustained rotation within and across assets.

In August, the market was reminded that although collapsing bond yields provide a mechanical boost to equities, “too far, too fast” can (and will) be interpreted as a harbinger of recession.

Once that threshold is reached, bond rallies can become pernicious, especially if the short-end refuses to keep pace, and the attendant bull flattening leads to inversions.

Given that, it came as some relief in September when yields began to rise anew off the August panic lows (and remember, some of what the market witnessed in the long-end in August was down to hedging flows). After spending the first half of 2019 squarely in the “bad news is good news” zone wherein dour data is good for bonds and stocks (with the latter benefiting from concurrent expectations of monetary accommodation), the regime has flipped.

And yet, as Goldman writes in a new asset allocation piece, “higher bond yields without better growth can quickly become self-defeating, as both 2015 and 2H 2018 illustrated”.

Just as “too far, too fast” on the downside for yields can signal recession, “too far, too fast” on the rebound tightens financial conditions and, if it’s not accompanied by better growth outcomes, serves as a “pure” drag on risk asset performance and, ironically, growth itself.

“In 2015 and 2H 2018, bond yields rose, led by US 10-year TIPS yields as the Fed tightened monetary policy, narrowing the gap to US 10-year breakevens.”, Goldman goes to recap, adding that “this created too much ‘competition from cash’ for other assets and tightened financial conditions, which weighed on growth”. As a reminder, cash outperformed some 90% of global assets in 2018.


So, in order for a true risk-on, cross-asset rotation to take hold, any rise in bond yields needs to be accompanied by a convincing rebound in growth and a current rise in inflation expectations (i.e., breakevens need to lead in a bond selloff for it to be “healthy”).

“For a sustained rotation higher, bond yields should be led by rising inflation expectations, which have been closely linked to the performance of cyclicals vs. defensives, i.e., growth”, Goldman goes on to say.

And yet, any fiscal push strong enough to resurrect the reflation narrative still seems like something of a pipe dream. “Another wave of fiscal stimulus, similar to 2016, could drive such a sustained rotation but it seems too early for that”, Goldman cautions, noting that fiscal policy in both China and the US is “more constrained this time”.

The US is staring down trillion-dollar deficits thanks in no small part to the Trump administration’s late-cycle plunge into supply-side economics and Beijing is still clinging to the idea that it’s possible to keep growth relatively stable without abandoning the deleveraging campaign and without “flooding” the system with liquidity.

As far as Europe goes, Goldman writes that “a large fiscal boost supported by negative rates, might only happen if growth deteriorates further”. By then it may be too late.

In the latest edition of BofA’s European credit investor survey, clients overwhelming said the most bullish catalyst for risk assets over the near- to medium-term would be a fiscal push from Europe (read: Germany).


If “animal spirits” and the reflation theme fail to show up and any bond selloff ends up being led by real yields rather than breakevens, it could constrict growth and imperil risk assets anew.

On the bright side, growth outcomes tend to lag monetary policy action, so perhaps better days are ahead.

“Easier financial conditions should eventually feed through to growth, especially if policy uncertainty eases, unless the easier monetary policy YTD has become less effective in boosting growth; there is a large gap between growth and FCI changes”, Goldman goes on to say, in the course of pointing to the first signs of bottoming out in the global manufacturing slump.

“After the longest slowdown since the late 1990s, global manufacturing PMIs have increased in the last 2 months”, the bank says.


Green shoots, as it were.


4 comments on “‘Higher Bond Yields Without Better Growth Can Quickly Become Self-Defeating’, Goldman Warns

  1. George says:

    What comes to mind is that when monetary policy is conducted with the goal of perpetuating the wealth effect and the goal is accomplished by finally hyper inflating asset prices at the expense of real returns then we have altered one of the primary rules of our existing financial system.. Where we inevitably wind up is …right where we are now…

  2. vicissitude says:

    What Happens if Central Banks Misdiagnose a Slowdown in Potential Output
    September 27, 2019

    In the last few decades, real GDP growth and investment in advanced countries have declined in tandem. This slowdown was not the result of weak demand (there has been no shift along the Okun curve), but of a decline in potential output growth (which has shifted the Okun curve to the left). We analyze what happens if central banks mistakenly diagnose the problem as insufficient demand, when it is actually a supply problem.

    Moreover, low interest rates will lead to an increase in the capital output ratio, a low return on capital and high leverage. We show that these forecasts are in line with what has happened in major advanced countries.

    The results in this paper suggests that the often-held view that investment in advanced countries is ”too low” may not be correct. Investment is indeed lower than in the past, but this is because n + g has fallen. Raising investment without a corresponding increase in TFP ( total-factor productivity *) or working age population growth may simply further boost capital-output ratios and further reduce the return on investment. In fact, if a country with
    low n + g has high gross investment, it will not end up with high growth, but with high
    capital consumption, as the example of Japan demonstrates.
    They also suggest that a prolonged period of low policy rates may lead to a decline
    of the natural rate of interest. If low policy rates lead to a high capital-output ratio,
    continued high gross investment (and thus low policy rates) is needed just to stay put.

    TFP is calculated by dividing output by the weighted average of labour and capital input, with the standard weighting of 0.7 for labour and 0.3 for capital.[3] Total factor productivity is a measure of economic efficiency and accounts for part of the differences in cross-country per-capita income.[2] The rate of TFP growth is calculated by subtracting growth rates of labor and capital inputs from the growth rate of output.[2]

  3. One of the few instances when timing bond funds ended up being a decent strategy.

  4. vicissitude says:

    The Japan model is worth pondering, i.e., how do lower rates stimulate an economy, versus stimulate bank reserves. QE seems to be fairly pointless in real world outcomes and as the paper above notes, as interest rates go lower, that increases non-performing loan problems, which of course causes banks to take on greater risks in their casinos. While there may be short term spikes in market activity related to QE and pending ZIRP policy, the longterm deflation trap is something that will be a Yuge part of the future.

    Looks like yields will continue downward globally for at least the next year and if a recession phases in, rates will go towards zero globally, so get ready to party with the big banks!

    Random FRED chart on interest rate spreads:

    Curious matters:

    ==> The United States 10 Years / Germany 10 Years Government Bond spread value is 213.7 bp (last update 19 Oct 2019 20:15 GMT+0).

    Spread changed -3.6 bp during last week, -16.2 bp during last month, -60.6 bp during last year.

    The United States 10 Years / Germany 10 Years Government Bond spread reached a maximum value of 279.6 bp (6 November 2018) and a minimum value of -91.6 bp (18 December 2008)*.

    ==> The Japan 10 Years / Germany 10 Years Government Bond spread value is 24.3 bp (last update 19 Oct 2019 18:15 GMT+0).

    Spread changed -1.6 bp during last week, -4.5 bp during last month, +54.7 bp during last year.

    The Japan 10 Years / Germany 10 Years Government Bond spread reached a maximum value of 48.4 bp (15 August 2019) and a minimum value of -70.2 bp (15 February 2018)

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