International bond yield question

[PDXTabs]

I'm curious about recent bond yields. Specifically, these are the 10 year yields as of this morning (data taken from here: https://www.wsj.com/market-data/bonds), organized by yield:

• China 3.082%
• U.S. 1.582%
• Italy 1.338%
• New Zealand 1.101%
• Australia 0.921%
• U.K. 0.504%
• Spain 0.135%
• Japan -0.240%
• France -0.361%
• Germany -0.644%

Is it wrong of me to think that the market is pricing a lot more future risk into the US bonds than the UK, Spanish, Japanese, French, or German ones? People are willing to pay Germany to hang onto their money but the same is not true for the USA.

[HeadedWest2029]

I wouldn't make yourself go cross-eyed trying to understand why there are negative yields on EU bonds.  The biggest holder of negative yielding bonds is the ECB.  They are trying to trigger growth.  The 2nd biggest holder are Euro pension funds that are obligated to buy a certain percentage of bonds.  The majority of these things are held for governmental reasons or fiduciary responsibility, not individuals acting irrationally

[PDXTabs]

I wouldn't make yourself go cross-eyed trying to understand why there are negative yields on EU bonds.  The biggest holder of negative yielding bonds is the ECB.  They are trying to trigger growth.  The 2nd biggest holder are Euro pension funds that are obligated to buy a certain percentage of bonds.  The majority of these things are held for governmental reasons or fiduciary responsibility, not individuals acting irrationally

I know that the ECB is trying to trigger growth, I did not know about the pension funds. Is there a risk that instead of triggering growth the ECB with trigger a flight to other currencies?

[MustacheAndaHalf]

Over 10 years, currencies can fluctuate a lot more than 1-2%.  Here's some historical rates of how many Chinese yuan it takes to buy $1 USD:

2019 Aug, 7.09
2014 Aug, 6.15
2009 Aug, 6.85
2004 Aug, 8.28

So if you invested in Chinese bonds 5 years ago, you'd lose about -13% (buy 6.15 / $1, but then convert 7.09 / $1).  It's not so bad 10 years ago, only a -3% loss.  And if you invested 15 years ago, you'd have a gain of +17%.  But my point isn't being lucky or not, it's that currencies can fluctuate more than a few percent over 5 or 10 years.

[habanero]

Is it wrong of me to think that the market is pricing a lot more future risk into the US bonds than the UK, Spanish, Japanese, French, or German ones?

Yes, that's wrong of you.

The most obvious reason is that the US, Japan and UK have their own currency. France, Spain and Germany do not.
Secondly, the bonds are denominated in different currencies. The central bank rate, and expectations of the future rate influence bond yields regardless of how risky they are.
Thirdly, bond yields are highly dependent on inflation expectations and supply and demand of bonds.

If you want to compare credit risk in bonds you have to compare to something similar in the same currency. In that respect you can say that spanish bonds are riskier than french bonds which are riskier than german bonds. In the US bond market you basically judge credit risk by the yield differential to US treasuries.

Take Norway, which you could argue is probably the world's lowest sovereign credit risk. The bonds yield 1.25 - 1.5% at mom in our own currency - significantly higher than say spanish bonds which are way riskier.

[PDXTabs]

The most obvious reason is that the US, Japan and UK have their own currency. France, Spain and Germany do not.
Secondly, the bonds are denominated in different currencies. The central bank rate, and expectations of the future rate influence bond yields regardless of how risky they are.
Thirdly, bond yields are highly dependent on inflation expectations and supply and demand of bonds.

Isn't that another way of saying that deflation is getting priced into the German bonds? inflation + risk = -0.644% ?

EDITed to add: but I have a hard time believing that the ECB will tolerate deflation.

[habanero]

No, for inflation expectations to you look at the market for linkers (inflation-linked government bonds) or the market for inflation swaps. They both point to +ve inflation in the EUR-zone, albeit at a quite low rate.

A comman gauge of expected inflation is the 5y inflation rate in 5y time (aka the 5y5y inlfation swap). It looks like this:

For reference the same inflation swap in the US trades around 1.90% (1.25% at mom for EUR inflation). So while the US has higher inflation expeectations they are not very high in the US either. In other words, you cannot deduct expected inflation from the yield on sovereign bonds.

[bwall]

EDITed to add: but I have a hard time believing that the ECB will tolerate deflation.

The ECB is much more comfortable with deflation than inflation.

Here's my reasoning: Germany is the largest economy and has the strongest export sectors which results in having more money to put into the till. As a result, the ECB is indirectly run by the Germans, whether the rest of Europe likes it or not.

Germans are very risk averse and have a long memory about hyperinflation that led to terrible things happening across Europe, the least of which was the complete and total destruction of their own personal wealth. Unemployment will be tolerated, but not inflation. German politicians will be re-elected in a high unemployment environment, but not a high inflation environment.

In a nation of savers, deflation rewards savers and penalizes borrowers. And, Germany is a nation of savers. So politically deflation would be much more acceptable than inflation, even though deflation is currently unlikely to occur.

Keep in mind also that Germany runs a government surplus (!) and has for the past couple of years (!!!). So, technically, they don't need to borrow new money, even though I'm sure they do to keep the gears moving.

[PDXTabs]

Interesting. For a long time I have been very pro-EU but anti-Euro. Forcing Germany and Greece to share the same currency seems bonkers to me.

[bwall]

Interesting. For a long time I have been very pro-EU but anti-Euro. Forcing Germany and Greece to share the same currency seems bonkers to me.

The EU is a great institution, IMHO. It stopped the shooting in Northern Ireland after 30 years (!). The Good Friday Agreement let everyone in Northern Ireland pick their passport, either Irish or UK. Since both countries were in the EU, it didn't really matter what they chose. All the catholics in N. Ireland picked the Irish passport (I suppose) and the protestants kept their UK passport (I suppose). Now that the UK is pulling out of the EU, there is a world of difference between a UK and an Irish passport. Look for the killing in N. Ireland to resume if the UK pulls out.

The Germans didn't really want to give up their Mark. But, I think it was part of the deal done in order to get reunification. The French were more the drivers behind the Euro than the Germans, IIRC and pushed the Germans to accept the Euro in exchange for reunification. The economies across Europe are very different, but there is similar variance within the USA also. Compare the economies of Appalachia, Florida, NYC, CA and Montana and I think there is the same level of divergence as across the Euro zone.

The piece that is missing in the EU is political union that goes along with monetary union. That's the last piece of the puzzle. It might take another generation before the EU is ready and by then there might not be an EU anymore. Time will tell.