There's three entirely separate things that we could pull from the current volatility of the bond and other investment markets. Our problem is that they're rather contradictory things and the public policy response to each of them should be different. And as ever in macroeconomics we've not really got enough information to know which is the correct answer: we've thus really not got much clue as to what we should be doing about it. And, as ever again, this is the basic problem with our trying to manage something as complex as the economy in the first place. We generally don't have much data, what we do have is often contradictory and thus macroeconomics isn't as firm a guide to policy as both some would like and some seem to think.
So, to the three things that could be happening:
Bonds and stocks retreated, extending a rout that’s wiped more than $2 trillion from global markets in less than two weeks. Metals fell with emerging currencies.
German 10-year bund yields rose seven basis points by 8:18 a.m. in London, and the rate on similar Japanese bonds jumped seven basis points. The Stoxx Europe 600 Index fell 0.8 percent and Standard & Poor’s 500 Index futures slid 0.3 percent.
Well, that's what is actually happening. And the FT offers us two reasons as to why it is:
A more worrying explanation is that bond markets no longer have the capacity to behave rationally, adding to the evidence of last autumn’s “flash crash” in US Treasury yields. Some investment bankers put this down to regulations that sap their ability to make a liquid market. Another explanation is that herd mentality becomes worse when yields are low — the upside is small, while the potential losses anything but. In such circumstances, the rush for the exits can be chaotic.
To some extent I would buy into this. After the crash we've had a lot of changes in financial regulation. Things like Dodd Frank and so on. And when I look at the changes that affect my professional life I'm appalled at the near ignorant way in which the rules were crafted. So I don't have great hopes that the parts about financial regulation were done any better. So I can well believe that those who crafted the laws and regulations were sufficiently bozo-like that they could have messed up the ability of the markets to operate. The implication of this is of course that we need to go back and revisit that regulation.
Then there's an alternative explanation:
Bill Gross, the legendary (non-fictional) bond trader, has recently called the end of the 35-year bull market in government debt. Just as it took the action of determined central bankers to bring to a close the era of high inflation, they do have the tools to lift bond yields off the floor and keep them elevated. Despite the fireworks that may follow, it is surely better the shift happens sooner rather than later.
Are we just seeing a turn in the tide of economic affairs? At which point we should be doing pretty much nothing of course. Although it is going to be interesting to see the current generation of bond traders deal with something they've not really experienced, a bear market.
A final and third possibility is that this is the final arrival of the bond vigilantes. People have finally woken up to quite how much governments are borrowing, how many bonds are out there, the size of the money supply and the pitiful yields on offer and are thus stampeding for the exits. While it would be amusing to see those who predicted such behaviour vindicated (on the simple grounds that many have been sneering at them for said prediction) this is by a long way the least likely cause of current events. If it is the cause then interest rates will need to come back up a lot sooner than anyone would be happy with for any other reason. So we would have to do something, but not something we'd like to do. Fortunately this is the least likely cause so we'll almost certainly not have to do it.
