“No Information Content”: Goldman Explains How The Fed Broke The Market

Wednesday, November 8, 2017
By Paul Martin

by Tyler Durden
Nov 8, 2017

When looking at variations in the short and long-end of Treasury curves in Europe versus the US, Goldman’s Francesco Garzarelli has made a remarkable observation: whereas market expectations of the trajectory for monetary policy in the US and Euro area continue to diverge, manifesting in a growing delta in short-end yields, the correlation of returns on long-dated bonds on the two sides of the Atlantic remains very high. The explanation for these cross-country dynamics, according to Goldman, can be traced back to the behaviour of the term premium, which is technically defined as the excess yield compensation investors usually require for holding long-dated bonds, but in practice is the umbrella “fudge factor{” term used to “explain” central bank impacts on longer-dated bond prices and moves.

These two dynamics are shown in the charts below: while short-rate expectations continue to diverge between the US and Europe (left), the term premia in the US and the Euro area bond markets have tracked each other increasingly closely, especially since 2014 (right).

Whereas several years ago there was a broad disageement over what is the primary driver behind the depressed term premium, gradually the analyst community was forced to admit reality, and accepted that the term premium is merely another way of calling central bank intervention on bond prices. Indeed, Garzarelli admits as much, saying that “low term premia reflect both the present macroeconomic environment and central banks’ actions.”

As Goldman futhers explains, while “historically, the premium tends to decline in economic expansions, when investors are less wary of bond price fluctuations. Low consumer price inflation, particularly when associated with greater confidence that it will remain contained, also acts to depress the term premium. But there is more to the decline in term premia during this cycle than can be ascribed to the growth and inflation outlook.”

The chart below from Goldman shows a growing undershooting of the aggregate term premium on 10-year bonds in the major economies from where historical relationships with macro factors would have it. “This departure from historical norms coincides with the introduction of negative rates and sizeable purchases of long bonds by the ECB and the BoJ.” In other words, the nearly 1% delta can be attributed to the actions of one or more central banks.

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