In the Financial Times, Mohamed El-Erian warns readers to “never underestimate the power of central banks intervening in market pricing.” He’s referencing the recent turbulence in treasury market yields, and the Fed’s role in causing it. He writes:
The combination of extremely low and relatively stable US government bond yields has confounded many market watchers for quite a while now, also challenging traditional economic analyses.
This has made the move up in yields over the past couple of weeks particularly notable, raising interesting questions for markets, policies and therefore the global economy.
It is usual to characterise US benchmark government bond yields as the most important market indicator in the world. Traditionally, they have signalled expectations about growth and inflation in the world’s most powerful economy. They have been the basis for pricing in many other markets around the world.
Breaking with a long history, these benchmark measures decoupled in recent years from economic developments and prospects. Their longstanding correlations with other financial assets, including stocks, broke down.
And their information content became distorted and less valuable. Coming out of the 2008 global financial crisis, this was attributed to excess global savings that exerted consistent downward pressures on yields.
With time, however, it became clear that the main driver was the ample and predictable purchasing of government bonds by the world’s most powerful central banks under quantitative easing programmes, particularly the US Federal Reserve and the European Central Bank.
One should never underestimate the power of central banks intervening in market pricing.
The trillions of dollars of bonds purchased by the Fed and ECB have distorted the usual two-sided markets and encouraged many to buy a whole range of assets well beyond what they would normally do on the basis of fundamentals.
After all, what is more assuring than a central bank with a fully-functioning printing press willing and able to buy assets at non-commercial levels. Such purchases legitimatise previous private sector investments and provide assurance that there will be ready buyers of assets for those needing to sell to reposition portfolios.
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