September promises to be a busy month for the world’s major central bankers. The ECB met this week, although it did not change its bank rate, it hinted  a  possible expansion of its QE program in the wake of its revised forecast for lower growth and weaker inflation. Later this month, the Federal Reserve’s FOMC meets to deliberate on the need for a rate increase, as some of its more influential members argue that the U.S. economy is ripe for an increase in the fed funds rate. And, the Bank of Japan will meet to debate its negative interest rate strategy along with its aggressive QE program, now extending to corporate bonds and selected equities. There is a lot on the bankers’ plates these days, especially as the economic growth rate slows in just about every region.

The bankers will be carefully reviewing the world’s bond markets. Some analysts argue that rates are too low and this signifies a market that is “too hot”, -- in other words ,we are in the midst of bond bubble—a very unhealthy situation that will only end in tears. Other analysts would argue that the bond temperature is “just right” in the sense that rates are reflective of subdued expectations of growth and longer term inflation globally.  Let’s take some temperature readings of the major government bonds markets. The accompanying panel of charts illustrates the movement of yields for 10 year bonds in the United States, Japan, the United Kingdom, Germany and Canada this year.

United States 

The United States continues to have the highest yield level of these major countries, reflecting the view that growth will continue to be positive and inflation, while falling short of the Fed’s goal of 2 percent, will nonetheless remain positive. However, the 10 year bond yield has dropped dramatically by over 60 basis points (bps) since the beginning of the year --- one of the largest falls in such a short time. Not shown here is the shape of the yield curve which has been undergoing a “bear” market flattening pattern. That is, yields in the long end of the market are falling, while the short end has moved up in anticipation of at least one Fed rate hike before year’s end. The flattening also signifies that the bond market is saying to the Fed that a rise in short rates will harm the economy and possibly create a recession. Do so with great caution.

Figure 1 U.S. 10 yr bond

Germany 

The German 10 year bund has a precipitous drop in yield from 0.6 percent to minus 0.1--- 70 bps. As the ECB undertakes an aggressive bond buying program of sovereign debt, the bunds are a favorite security. Moreover, the deflationary forces operating in the Eurozone. This encouraged the ECB to adopt an aggressive  bond buying program. There is concern that the ECB purchasing  will exhaust the supply of eligible sovereign debt. In addition, the ECB has undertaken to purchase corporate bonds. Without a dramatic turnaround in economic growth and inflation, the bund will continue to trade in negative territory.

Figure 2 German 10 yr bund

United Kingdom 

The most dramatic fall in yields has taken place in the U.K. from 2 percent to 0.75 percent. Much of this decline took place prior to the Brexit vote in June. The result of the vote has only intensified the collapse in the yield of the 10 year gilt. Investors have taken a very dim view of the longer term prospects for the U.K. post-Brexit. Some of this fall in yield may have been an overshoot as part of a knee-jerk reaction to the vote, but the basic trend is unmistakably downward.

Figure 3 U.K. 10 year gilt

Canada 

The decline in Canadian bond yields is a reflection of the weakness in the economy following the collapse of oil prices and other commodities in late 2014. Although the Canadian inflation rate is running a little high relative to its trading partners, the Bank of Canada has chosen to promote growth above all else and has kept the bank rate at 0.5 percent. The Bank makes it quite clear that the risks to the economy are on the downside, reinforcing the view that long term rates will remain at these levels or possibly go lower.

Figure 4 Canada 10 year bond

Japan 

The world has been watching Japan, in disbelief, as Japanese government bonds up to 20 years are now trading in negative territory. Japan has a host of factors that contribute to  its historic low rates--- a shrinking population, more than a decade-long deflation, and a rising exchange rate. The negative yields have been generated from a very aggressive bond buying program which has been extended to include corporate and equities. Japan continues to fight an uphill battle to re-inflation the economy.

Figure 5 Japanese 10 year bond

What is the temperature reading?

It is no coincidence that all these markets saw a huge fall in long term rates. The downward  march in long term yields came after the Fed hiked its bank rate 25 bps in December, 2015. Collectively, the markets viewed that move as either premature or not needed at all, and hence the long rates fell over concern about the strength of the major economies. This result should give the Fed some pause when considering whether to hike rates this year.

As to the question whether the bond markets are“ too hot” or overheated, it is hard to make the case that bond yields are mispriced (i.e. too low). In all instances, these markets reflect the weakness in growth and the absence of inflation. The market temperature, if anything, is just right.