<p>Financial markets produce dozens of indicators from stock indices, alternative asset prices, inflation, growth and productivity measures. Each of them is significant in the analytical process to determine the strength of an economy and the confidence, amongst investors, as to its future performance. But, in the view of your columnist, the single most important indicator that really sums it all up, is the yield on 10- year treasuries. It takes into consideration the impact on the economy of fiscal deficits, productivity rises, future demand, amongst other essential factors.</p><p>But bond yields are a double-edged sword, when it comes to predictions. It is true that financial markets are not the only forecaster of events. But it is also true that they are one of the most carefully followed. Bond yields are different to central bank rates and it is necessary for business executives, specifically CFOs, to understand why this is so. When a central bank decides to lower rates, what it is actually doing is reducing its target for overnight borrowing costs. But the ten-year yield is more relevant and tangible, because it serves as a benchmark for everything from corporate bonds, personal loans to mortgages. And long-term yields respond to economic conditions more broadly—not just to the central bank’s short-term target.</p><p>The issue to grapple with, is whether governments can really influence bond yields. The answer is really not that simple. Markets are not so much influenced by words as they are by figures and actions. So, when politicians say they intend to reform, to make things more efficient, the markets may react briefly. But in the longer term the greater impact on bond yields comes from figures and scores, for instance long-term growth and inflation expectations, the economy’s productive potential and the government’s fiscal trajectory, which helps dictate the supply of and demand for its bonds. All of these take time to affect yields.</p><p>10-year yields can offer conflicting messages. On the one hand, a rise might indicate that market confidence in the economy is falling and investors demand higher returns in exchange for their money. This could be the outcome of higher government spending and consequently larger deficits, which impact the price of money. On the other, higher yields may also suggest that investors subscribe to the belief that the economy may over heat in the years ahead with a consequent rise in inflation.</p><p>Politicians across the world often fall into temptations of populist policies. These involve higher levels of spending, either to appease constituents or pump-prime growth. Their only real restraint is the bond market, which responds through demands of higher returns for their investment in treasury paper. As Bill Clinton assumed the presidency of the United States, in the 1990s, he fell short of fulfilling his election promises towards a massive social spending programme. Bond yields jumped, pushing higher costs to the treasury and Mr Clinton’s policy initiatives became unviable. James Carville, the president’s adviser famously remarked that he wished to be reincarnated as the bond markets, so that he could intimidate everyone! In addition to being a crucial indicator of an economy, bond markets discipline politicians. They should also be used as an input to the algorithms used by companies to forecast demand, growth and cost of funds.</p>
<p>Financial markets produce dozens of indicators from stock indices, alternative asset prices, inflation, growth and productivity measures. Each of them is significant in the analytical process to determine the strength of an economy and the confidence, amongst investors, as to its future performance. But, in the view of your columnist, the single most important indicator that really sums it all up, is the yield on 10- year treasuries. It takes into consideration the impact on the economy of fiscal deficits, productivity rises, future demand, amongst other essential factors.</p><p>But bond yields are a double-edged sword, when it comes to predictions. It is true that financial markets are not the only forecaster of events. But it is also true that they are one of the most carefully followed. Bond yields are different to central bank rates and it is necessary for business executives, specifically CFOs, to understand why this is so. When a central bank decides to lower rates, what it is actually doing is reducing its target for overnight borrowing costs. But the ten-year yield is more relevant and tangible, because it serves as a benchmark for everything from corporate bonds, personal loans to mortgages. And long-term yields respond to economic conditions more broadly—not just to the central bank’s short-term target.</p><p>The issue to grapple with, is whether governments can really influence bond yields. The answer is really not that simple. Markets are not so much influenced by words as they are by figures and actions. So, when politicians say they intend to reform, to make things more efficient, the markets may react briefly. But in the longer term the greater impact on bond yields comes from figures and scores, for instance long-term growth and inflation expectations, the economy’s productive potential and the government’s fiscal trajectory, which helps dictate the supply of and demand for its bonds. All of these take time to affect yields.</p><p>10-year yields can offer conflicting messages. On the one hand, a rise might indicate that market confidence in the economy is falling and investors demand higher returns in exchange for their money. This could be the outcome of higher government spending and consequently larger deficits, which impact the price of money. On the other, higher yields may also suggest that investors subscribe to the belief that the economy may over heat in the years ahead with a consequent rise in inflation.</p><p>Politicians across the world often fall into temptations of populist policies. These involve higher levels of spending, either to appease constituents or pump-prime growth. Their only real restraint is the bond market, which responds through demands of higher returns for their investment in treasury paper. As Bill Clinton assumed the presidency of the United States, in the 1990s, he fell short of fulfilling his election promises towards a massive social spending programme. Bond yields jumped, pushing higher costs to the treasury and Mr Clinton’s policy initiatives became unviable. James Carville, the president’s adviser famously remarked that he wished to be reincarnated as the bond markets, so that he could intimidate everyone! In addition to being a crucial indicator of an economy, bond markets discipline politicians. They should also be used as an input to the algorithms used by companies to forecast demand, growth and cost of funds.</p>
