The Global Debt Crisis Builds

Falling short-term rates conceal a scary rise in global long-term yields

Back in September, I wrote a series of pieces on how falling short-term interest rates were concealing a scary rise in long-term yields. This issue has grown even more acute since then. The Fed has resumed its easing cycle, short-term interest rates have fallen further and longer-term yields - when properly measured - are at or near their highs. We’re in the early stages of a global debt crisis that’s building and intensifying.

The charts above show government bond yields across nine advanced economies. The black line shows the 2-year yield, which is largely cyclical and driven by what markets think central banks will do. The blue line is the 10-year yield, which is still somewhat cyclical, because - especially in recent years - it’s moved closely with 2-year yield. The orange line is 10y10y forward yield, which I back out from 10- and 20-year yields. The red line is the 10y20y forward yield, which I back out from 20- and 30-year yields. The appeal of these forward yields is that they strip out the front end of the yield curve and thus - by abstracting from cyclical noise - provide a cleaner read on what’s going on with long-term yields.

There’s a huge amount going on in global bond markets at the moment, so let me summarize what I think are the main points:

• Fed cuts aren’t pulling down long-term yields: if you look at the long end of the yield curve properly by stripping out front-end yields, things look very worrying. 10y10y and 10y20y forward yields are near their highs and the gap of both metrics with 10-year yield has grown. The buyers’ strike for longer-dated Treasury debt looks like it’s getting worse.

• There’s many idiosyncratic trouble spots: a key feature of the recent rise in long-term yields is that there’s many fiscally distressed countries that run into trouble at different points and for idiosyncratic reasons. Italy, France and the UK are all part of this dynamic and have very elevated 10y20y forward yields.

• Traditional safe havens are failing: in the past, Japan and Germany would have been safe harbors in this kind of environment, but these days they’re at the heart of the rise in long-term yields. In Japan, this is because the Bank of Japan (BoJ) is stepping back from keeping long-term yields artificially low in order to stabilize the Yen. In Germany, it’s about the current government’s large fiscal stimulus and recent moves to soften up the debt brake.

For all our advances in economic modeling, we don’t really understand what sparks a debt crisis. Debt at 100 percent of GDP can be perfectly sustainable if markets are fine with low interest rates. But if markets change their mind and start demanding higher interest rates, that same level of debt becomes unsustainable. In other words, there’s multiple equilibria and we don’t really know what shifts you from a good to a bad one because the difference is human behavior. That’s why it’s so critical to monitor long-term yields at high frequency. They’re the best way to track market attitudes towards debt and the picture is growing increasingly worrying.