Wednesday, 31 March 2010

The 'I'm really getting tired of this nonsense' guide to bond yield trends

Michael Taft: There are others who will discuss intelligently the fall-out from Ireland’s financial Black Hole Day (Sli Eile, Stephen Kinsella and Nat O’Connor on this blog for instance). One thing that struck me during the Finance Minister’s robust, if economically-challenged, interview on Prime Time was his contention that things were, like, totally cool. Why? Since he announced the massive give-away, bond yields hadn’t moved. Wow. He made his announcement at 4:30 pm and by 10:00 pm bond yields hadn’t moved. This proved that not only that the international markets were not ‘concerned’ with our financial black hole, they were positively chill (or they just go to bed early).

One could really get tired of this. There’s an eerie anthropomorphic quality to discussions on bond markets. Apparently, these markets can ‘feel’, ‘be happy’, ‘become angry’, ‘contemplate’, etc. and on and on. The trend of commentary usually goes like this: ‘the markets will be concerned if the Government doesn’t get tough on trade unionists, the poor, public spending and businesses in debt’. And when the Government does do tough guy stuff, the bond markets ‘approve’ and so, are at peace.

All this comes from the sound-bite school of deep, thoughtful analysis. Tracking bond yields can tell us many things – and it’s amazing that what it usually tells us is what we want it to tell us: vide the Finance Minister last night. So in that spirit I have constructed my own way of explaining bond yield trends. I have used the gross redemption yields for 10-year plus bonds on the last day of the month, sourced from ISEQ (one of many ways to track borrowing costs). This is what the ‘markets’ are telling me.

APRIL 2008: We are still innocent. The ESRI has yet to discover the recession and predict 3.1 percent growth for 2009. There is talk of property prices but we are assured it will be a soft, gentle landing. AIB is trading at €13.25. In another country baseball season is starting and little boys will be playing well into the bright summer evenings.

Bond Yield: 4.40

SEPTEMBER 2008: The boys of summer are still playing baseball but the financial dogs in the street are muttering something about Irish banks and insolvencies. The Sunday Independent declares that if anything goes wrong, whatever that might be, it will of course be the fault of trade unions. Bank Guarantee announced at the end of the month. Markets don’t have time to react before month’s end because they go to bed early.

Bond Yield: 4.60

OCTOBER 2008: Bankers say everything is fine and they don’t need equity; the markets get worried. AIB trades at €5.00 but no one is fired. Bringing forward the Budget doesn’t help either – especially this budget.

Bond Yield: 4.84

DECEMBER 2009: Markets get less jittery. All that hysterics about the state being exposed to hundred of billions of bank Euros fade away. ISME calls for the suppression of trade unions. Their competitors, the Small Firms Association, call ISME weak on the issue of trade unions.

Bond Yield: 4.47

JANUARY 2009: Everything goes haywire. Markets up in arms. Is it because Anglo-Irish is nationalised or because the Government, only a few days before, was going to pump billions in it because they believed it was still viable? The markets unsure whether the Government was colluding in a tissue of lies and deceit or are just plain idiots. Live Register experiences biggest jump in two decades.

Bond Yield: 5.54

FEBRUARY 2009: The Government goes macho. They kick the unions out of Government buildings in the early morning (and don’t even call them a cab). The Finance Minister announces a pension levy on public sector workers and cuts in the number of special need teachers. Pumped abs and testosterone everywhere. Commentators note that even the weather has improved. The markets, however . . .

Bond Yield: 5.57

MARCH 2009: The Tánaiste declares the Government has public finances under control. No one, not even the omnipotent markets, knows what to make of this.

Bond Yield: 5.45

APRIL 2009: Just to prove the Tánaiste was right, the Government introduces an emergency budget. The markets don’t understand – consumer spending is collapsing, businesses reliant on domestic sales are collapsing; and the Government takes even more money out of people’s pockets. There’s counter-intuitive and there’s counter-intuitive; and then there’s Fianna Fail.

Bond Yield: 5.28

JUNE 2009: The markets reconsider the Government’s emergency budget and their deflationary strategy of cutting €11 billion out of an already debilitated economy over the next four years.

Bond Yield: 5.84

AUGUST 2009: For months the three major credit rating agencies have been downgrading Irish Government debt and are threatening more. Commentators are horrified and claim we’ll never be able to borrow again ever, the Sunday Independent blames trades unions, employers demand the minimum wage be cut (though no one can figure out how this will get cheaper money). The markets, however, prove they have a sense of humour.

Bond Yield: 4.68

THE AUTUMN RUN-UP TO THE BUDGET - NOVEMBER 2009: Everyone is giddy. If the Government keeps their promise to implement a puppy-crunching, Bruce Lee, in-your-face, take-no-prisoners budget, the markets will smile and investors will actually pay us to borrow from them. The Taoiseach promises blood, sweat and bankruptcies, the Tánaiste claims that what ever makes us redundant only makes us stronger; the Minister for Health (sic) goes one better and threatens IMF tanks in every town square in the country if we don’t take the pain.

Bond Yield: 5.16

DECEMBER 2010: The Government introduces a puppy-crunching, Bruce Lee, in-your-face, take-no-prisoners budget.

Bond Yield: 5.18

[For a few weeks everyone’s attention is on Greece and those irrational Greek workers striking and marching in the streets because they don’t want to be the fall-guys and fall-gals for maintaining a strong Euro, Germany’s current account surplus and finance capital’s hopes for a return to Alpha status.]

MARCH 30th 4:30 – 10: 00 pm: The Minister declares markets are totally cool with him shovelling up to €20 billion in Anglo-Irish (proves what shrewd market players the Cabinet are), that the economy has turned the corner, unemployment is stabilising and we’ll return to growth this year. Recession? What recession? The only recession is in your mind, dude.

Bond Yield: Moved not one cent according to the Minister.

* * *

All that – all that courageous action the Government has taken that has so impressed the markets – and bond yields are worse than when we started on this dismal path. Of course, there will be those who will claim that if the Government didn’t take courageous action, borrowing costs would have been worse. If so, then why is it high bond yields got worse every time they did?

That’s one way of looking at all this. For another perspective have a read of Michael Burke’s take on borrowing costs and the Government’s deflationary policies. You might have your own perspective. If so, go on to the Irish Stock Exchange website and build your own story.

But, please, just don’t make the markets ‘nervous’.


Rory O'Farrell said...

The government spread a myth that the last budget lead to the reduction of bond yields. Here is a graph from Bloomberg.

As can be seen, bond yields were fairly stable from about August to the start of February, and have declined since February. This February decline is hardly attributable to the budget. All that happened is that Greece was worse.

Michael Burke said...

The cart here shows the yield spread between German and Irish 10yr government bonds. The Bloomberg axis has gone a bit haywire, but the directional movement is right.

The yield spread was over a number of year's within a hair's breadth of the German benchmark yield. They stated to part company at the time of the first fiscal auterity measures in Ireland, October 2008.

The bank bailout is unlikely to have helped matters much, weither on the economy, the deficit, or on yields.

But it is clear that it the spread-widening, at additional huge cost to the taxpyaer is not the driver of the widening, as anothr huge bailout announced yesterday had no apprecable effect.

Germany, rememebr, had a significant fiscal stimulus whwereas Ireland has slash&burn.

I know, I know, Ireland is an SOE, which invalidates all other logic. We are not the same size as Germany. True, but geographically Ireland is no smaller now than in early 2008 when it had almost identical yields to Germany.

David O'Donnell said...

Yes. This Bond-Mawrket, [speak with Awe, tones of the Divine] has been successfully projected, spun as the modern equivalent of the Holy Ghost - it that must not be upset on pain of the horrors of Hell.

We could, and should have, cut a deal with senior Anglo-Irish bond-holders, - they would take it on the chin [Germany, France, UK] as 'rational' 'sensible' in dealing with a Klepto_Cowboy bank - and it would have had minimal impact on ability of Irish sovereign to raise funds - and enhance our reputation if we had Exec with an ounce of balls. Now - they may not even bother to take out insurance - why bother - The Irish Fools will Pay 100% no matter how dodgy the holders.

Martin O'Dea said...

It's been leaked - the whole NAMA thing and all that ........scroll down........April's fool.

Sources close to the mary's and brian's say that they will come out of government buildings tomorrow morning at 9 am with massive smiles and winks and tell us that the whole thing was a massive two year piss take.

Already people who were definitely duped have been heard exclaiming that they knew it was a joke all along. 'There was no way that the people of the country would actually have to cough up billions over coming years for a couple of poxy banks, and building companies, that spent half their lives overcharging them'. 'It was a good one all the same' said another

Mack said...

@Michael Burke

Is it credible that the tax rises announced in October 2009 increased Ireland's likelihood of default to a greater extent than the banking guarantee (announced 29th September 2009)?

Patrick Honahan has a useful graph of the _gradual_ increase in the spread over German bond yeilds starting on the 1st of September 2008.

It trends steadily upwards throughout September / October / November (international banking crisis) and spikes like mad around Anglo's nationalisation at the start of 2009.

Michael Burke said...


Thanks for directing us to the chart. It bears close scrutiny.

The bank guarantee was announced in late September 2008 and the bond spread moved up by approximately 20basis points (bps) over the following month.

The next event was emergency Budget measures. This was cast as necessary to avert a crisis in government finances. The spread had widened out at end-September to 65bps. A rise of 18bps over the month.

By the end of November, in the wake of the emergency Budget the spread was 105bps, yields rising 21bps on October 31st alone. That seems more dramatic than gradual.

By year-end the spread was 149bps, a rise of just over 100bps since the beginning of September, and before the nationalisation of Anglo-Irish.

That led to a blow-out on the spread to 227bps by end-Janaury 2009 and 247bps by end-March. Thereafter a period of 'normalisation' began in international fnacial markets, and the spread narrowed to a degree over time.

(One difficulty with the Honohan approach we are working with here is that, by monitoring the spread over Germany, it is impossible to isolate specifically Irish effects, as German yields tend to fall unilaterally when there is a panic, the 'flight to quality'. Better actually to compare Ireland to its pre-crisis peer group of non-benchmarks, ie Belgium, Portugal and Spain. The effect of nationalisation looks far less dramatic, but not inconsequential versus the peer group, an average of 50bps).

That 'normalisation' has yields that are now 138bps above Germany- at end-March 2010.

Those who want to describe the blow-out in Ireland's spread as irrational, like Honohan, cannot explain the persistence of such a large spread (or, indeed, any cause for it).

Others want to ascribe it all to the bank bail-out. Well at least that's a rational explanation. And I yield to no-one in my abhorrence of the bail-out and NAMA. But it does not accord with the facts.

Indeed, that view could not explain why the spread has actually narrowed with the further nationalisations of Tuesday (138bps end-March, compared to 142bps end-February).

The explanation lies in the fiscal position and the government response to it. Greece, which has no banking crisis to speak of, yet anyway, has the highest yields in the Euro Area (344bps over Germany). Ireland is next with 138bps. Belgium, which has the second-biggest bank bailout after Ireland has a spread of 45bps. There is no correlation between bank bail-outs and size of spread, let alone causality.

Whether that is an appropriate reflection of fiscal risks arising from the banking sector is a different matter. I tend to take the view that huge fical risks are contained in the bank bail-outs. But this is not reflected in government yield spreads.

As for the rest of Ireland's pre-crisis peer-group, Ireland now has 10yr yields 24bps above Portugal, 54bps above Spain, and 93bps over Belgium.

All of them, with the exception of Greece, adopted fiscal stimulus measures, not Ireland's slash&burn. There is then a very clear verdict as to who actually 'reassured the financial markets'.

Mack said...

Michael, I think in fairness to Patrick Honahan that blog was written a long time ago when the full extent of the problems in Anglo etc, where not clear. They're still not clear today.

This kind of a crash is a process rather than an event. I could agree with you that Ireland's deteriorating fiscal position had a big impact on the widening of the spread, but I also think the fact that the state had guaranteed the liabilities of the banks and that the perception of the probability of the guarantee being called in was rising steadily also had a big impact.

This article has a useful graph showing the spreads vis-a-vis Germany for a range of European countries.

You might be right on stimulus - but that doesn't mean that current spending isn't unbalanced. Ideally if we had zero-based decision making it could all be reworked and investments that would give a return could be brought forward or launched now.

Maybe with the agreement between the government and the Unions - if it passes - there'll be some space in which those who favour stimulus spending on productive investment could win support from those who prior to this point would have been suspicious of their motivations...