The message from the bond markets

Conventional theory holds that an inverted bond yield (in this case where the two year pays more than the ten year) is a negative economic forecast. I have never been quite clear on whether this is regarded as a causal relationship or simply an observable correlation. The former seems unlikely – that the sight of a threatening yield curve sparks widespread fear and recession follows as a result of cautious behaviour – but I have heard people talk as if that is the case.

It seems more likely that inverted bond yields are a response to or a forecast of tough economic times.

I prefer to remember that bond prices are the terms on which borrowers and lenders choose to trade. High short dated yields might imply inflationary fears but they also reflect the credibility, or lack of it, of the governments that need to borrow. Lower long dated yields imply scepticism about future growth but they also suggest the belief that returns from safe investments will revert to the modest levels that became normal in the last ten or so years.


The obvious flaw with the idea that low long term yields are normal is that it is probably wrong. We have been conditioned by more than ten years of government bond market manipulation by central banks.

In some countries like the US, the UK and the Eurozone, central banks have led the way with QE. It is a matter of opinion as to how independent of government influence these central bank actions have been. The fact that they have de facto financed unprecedented government borrowing, first through the Great Financial Crisis aftermath and then through Covid-inspired lockdowns, speaks for itself.


Here are UK ten year gilt yields since 1980. In the 80s they were in a 10-15% range and then a 5-10% range basically until 2008 when the estimated $60 trillion of outstanding credit default swaps began falling like dominoes, threatening numerous financial institutions around the world. The chart illustrates nicely the result of the critical need for cheap money around the world.

In context, the 2022 rise in gilt yields looks more like the beginning of a reversion to the old normal and less of a once in a lifetime buying opportunity. There will be plenty of selling of gilts by the Bank of England as it continues to raise substantial debt for the government and begins to dump its own holdings, accumulated at a monumental loss (£156 billion and counting) during the extended twelve year distortion of QE.

The general rise in long term rates is down to inflation fears but also to the fact that most central banks have at last allowed it to happen.


In some ways the list of countries with conventional yield curves is the more interesting. These are perhaps nations with very strong and controlling central banks (Japan, China, Switzerland) or rich natural resources (eg Australia, SA).

Conventional yield curves Inverted yield curves
2 year 10 year 2 year 10 year
Australia UK
3.24 3.69 3.72 3.65
South Africa US
7.3 10.16 4.28 3.68
China Germany
2.38 2.91 2.49 2.29
Japan Sweden
0.01 0.39 2.61 2.02
Switzerland Canada
1.1 1.4 3.74 3.01
France NZ
2.56 2.83 4.92 4.4
Italy South Korea
3.12 4.46 3.8 3.58
India Singapore
6.94 7.3 3.08 2.91
Turkey Sri Lanka
10.05 10.47 30.77 29.11

The fact that Germany has an inverted yield curve is readily explicable (inflation, high dependence on imported raw materials) but it seems surprising that the other eurozone countries (France and Italy for example in this table) have conventional curves. This implies to me ECB manipulation, maintaining a “nothing to see here” policy that also allows the more vulnerable member states to continue to borrow relatively cheaply, for now.

The steep slope of the inverted yield seen in Sweden is perhaps what one might expect from other European countries if their bond markets were not being managed. Sweden’s finance minister expects a recession to last into 2024. By contrast, Italy criticises the ECB for raising rates but the implied consequences for the Italian economy are not stated explicitly.

Premium of 2 year (%)
UK 1.9
Sri Lanka 5.7
Singapore 5.8
South Korea 6.1
Germany 8.7
NZ 11.5
US 16.3
Canada 24.3
Sweden 29.2


I should also highlight Sri Lanka (borrowing at c.30%), the country in which I was present when lockdown started (read about it here). The government drank the COP 26 Kool-Aid and banned the use of chemical fertilisers with the result that Sri Lanka’s harvest failed, its economy crashed and India had to send emergency food aid, despite the fact that Sri Lanka’s GDP per capita is normally twice that of India.

I read that the Netherlands has decided to make compulsory purchases of 3000 farms on the grounds of EU rules about nitrogen emissions. It will interesting how self harming that turns out to be.


It is easy to forget that most global bond markets have been distorted for half a generation. Money has been cheap and liquidity flowing. Investors have been so hungry for returns that they have tolerated fads, cryptocurrencies and Sam Bankman-Fried.

The shocking probability now is that the Federal Reserve and other central banks will choose recessions in preference to high interest rates. Recessions will be their cure for inflation.

The pressure on governments will be to borrow more than ever as their citizens scream for higher wages and subsidies. Whatever one’s political persuasion, ever higher government borrowing seems like a terrible idea.

Bond markets should now reflect the true price of money and the chances are that the price should continue to rise.

In the long run, growth is probably the only way out, though ironically the most recent champion of that idea, Liz Truss, was the UK’s shortest surviving Prime Minister.

Self harming ideas such as Net Zero deserve to expire out of embarrassment, based, as they partly are, on the complacent assumption that first world countries are wealthy and implicitly deserve to suffer. I regret to say that my current favourite quote is from 2019 and came from one Vladimir Putin:

“No one has explained to Greta that the modern world is complex and different and … people in Africa or in many Asian countries want to live at the same wealth level as in Sweden.”

I have a feeling that economic growth will return again because ultimately humans are not self-harming. But it will not be kick-started by lower interest rates.

Leave a Reply