Warning signal from US bond market

Democratic presidential nominee Joe Biden and his running mate Kamala Harris. Picture: AFP

Over many years the US 10-year bond rate has proven to be a better long-term trend indicator than the American share market.

Some two years ago the 10-year bond rate gave clear and correct signals of an emerging much lower American interest-rate environment, which spread around the world.

As the 10-year US bonds rose in price and the yields continued to fall it almost became “no news”. But if there is ever to be a change in the lower rate pattern, almost certainly it will be the market-driven US 10-year bond rate, rather than the central banks, that will provide the signal.

Over the last two months the US long-term bond rate has been creeping up from its low levels and earlier in the week the rate hit 0.734 per cent – a rise of 37 per cent over two months. The rate then eased fractionally.

I emphasise that these are low rates and it’s not a definitive signal, but suddenly the 10-year US bond rate must return to the alert list. The magnitude of the increase went against the popular view that the only way for interest rates to go is either even lower or to skate along the bottom.

The market blamed the increased bond rate on the fact that the much-awaited additional US stimulus was bogged down in Congress. That was obviously a factor but when the 10-year bond market moves significantly there are normally deeper forces than a Congressional hold up - particularly as both sides plan to stimulate after the election.

I believe that behind the latest rise in the 10-year bond rate was not just the stimulus issue, but also our first whiff of a fear that a number of deeper forces might emerge. The yield would need to rise further (and the bond prices fall) for us to make definitive conclusions but it’s important to set out these forces at the first signs of danger.

It is clear that Joe Biden, and particularly his strong vice president Kamala Harris, plan a very different US economy. Given the opinion polls it is almost certain they will win.

Biden and Harris will embark on a much bigger spending spree than Donald Trump and of course this is boosting the outlook for the share market and naturally makes bond buyers nervous.

But the Biden-Harris plan goes much deeper. They are planning to extend the Californian experiment across the US and so America will go much harder on green energy, will make it difficult to frack oil (the original plan to ban fracking has been modified), ban independent contracting and bring forward other Californian-style measures.

In California we have seen what happens when such a package of measures is introduced – unemployment rises faster than the rest of the US, there are blackouts and industries like technology start to look offshore. Extended it across the US too quickly and it would threaten low inflation.

Add that to higher income and corporate taxes and it’s a world where markets will fear inflation could start to rise again.

The small rise in the bond market certainly doesn’t mean the above scenario will unfold but in today’s very low interest-rate environment we have received our first warning signal that there is a change possible.

And sitting back and watching that US situation is, of course, China. In years gone past the huge Chinese trade surpluses that were generated as America switched its manufacturing to China were invested in American bonds, which helped the Americans pay for their goods.

To the extent that the Chinese purchased longer-term American bonds they have made a staggering fortune on paper.

Relations between China and the US are now very different and China itself is under pressure.

Selling the US bonds is not currently being canvassed. It would reduce the American dollar sharply and impact China’s trade. There is absolutely no sign that Chinese sellers were part of the 37 per cent rise in the yield but if the upward path in the 10-year bond rate is resumed then these deeper fears and speculations will become much more important.