On negative nominal 10 year rates

The news yesterday  (or here) that Switzerland had become the first country to sell new issue benchmark 10 year bonds at a negative yield, is just the latest headline in the extraordinary sequence of events that has unfolded over the last half dozen years.  The story isn’t primarily about Switzerland, but about a global collapse in nominal yields.  Even such allegedly robust economies as the United States and New Zealand have very low interest rates, not that much above the lows –  and, as various commentators have highlighted, these aren’t just multi-decade lows, they are multi-century lows.  In European countries for which there is data, during centuries when there was no trend in the price level (and hence presumably no expected inflation), nominal government yields still seem to have averaged around 3-4 per cent.

Market commentators in the FT story I linked to talk a lot about government policies ( as one says “Bond markets are heavily distorted by government policies. They won’t return to normal until central banks start raising interest rates again.”) but the bigger question is not about specific measures that individual governments/central banks are taking, but about why policy rates have needed to be at zero (probably ideally lower) for so long, and what makes a 10 year bond yield near-zero a better prospective bet than the alternatives.  ECB QE probably is lowering yields in many countries, but that QE (for example) is both being done for a reason, and is unlikely to be some quick panacea

Economic outcomes around much of the world have been staggeringly bad.  In the advanced world, taken together,  per capita GDP has shown little or no growth since 2007 (just before the recession began).  Best estimates suggest that a 2014 vs 2007 comparison for advanced countries isn’t that different than a 1936 vs 1929 comparison (although in most cases the Great Depression slumps were deeper and the recoveries stronger).    When I was working for the NZ Treasury in 2010 I wrote a discussion note suggesting that in many respects that world was less well-positioned then that it had been in 1930, but I’m not sure I quite believed it myself, and it is still sobering to realise just how badly things have gone.

Markets don’t expect much policy tightening in the advanced world in the next few years.  The exception is the US, and even there I suspect they and the Fed will once again have to revise down their expectations.

But what if bond yields are foreshadowing more weak growth and a sustained period of deflation?  We know that equilibrium real interest rates can’t go negative (consumption today will always beat consumption tomorrow, and nature continues to produce positive yields –  think untended fruit trees), but the obstacles to negative nominal rates are (a) for short-term assets only, and (b) reflect statutory/regulatory restrictions not fundamental economics.   If the near-zero bound on short-term interest rates were removed, prospects for higher medium-term nominal yields would increase.  But if it can’t be (or policymakers won’t) removed quickly, near-zero long-term bond yields could make a lot of  sense if, say, a decade of -2% annual inflation loomed.

Nothing guarantees such an adverse outcome, and if it happens it will take conventional wisdom very much by surprise (breakevens on long-term inflation-indexed bonds certainly aren’t negative).  But so has a lot else about the last 7-8 years.  Demographics increasingly don’t support investment demand. Advanced country fiscal and monetary space is all but exhausted, and much of the emerging world also appears to have  run the course of their own credit booms.  Most of those countries still have some policy leverage left but the world looks increasingly as though it is one shock from something very nasty.  Perhaps bond markets are telling as something, and implicitly reflect just such a nasty prospect.

How many mortgages are being approved?

Some years ago the Reserve Bank started collecting weekly data on housing mortgage approvals by the main lenders.  It is a great resource, partly because it is so timely –  the data released yesterday were for approvals granted last week.

The data aren’t seasonally adjusted, and so for a while I’ve been keeping an eye on a version of this chart, tracking the number of mortgage approvals per capita in each of the 52 weeks of the year.  New Zealand’s population is steadily growing, and so I’ve used an annual population estimate to produce an approximate series of housing mortgage approvals per capita.  You can see the holiday periods clearly –  not just the great Christmas/New Year dip, but also those for other public holidays (Easter accounts for last week’s dip). It is easy to see how mortgage approvals are running relative to the same period in earlier years.

The chart shows three lines.  The first is the median for the first 10 years of the series, 2004 to 2013, which encompassed the last few years of the boom, and the very weak few years after 2007.    The second and third are the series for 2014 and 2015 to date.  The number of mortgage loan approvals last year ran consistently well below the median for the previous decade.  And this year, the number of approvals per capita has been tracking a little lower again.   So far only 2010 and 2011 have been lower than this year.

Consistent with that, the total stock of loans to households has been growing at a touch under 5 per cent per annum –  barely above a plausible trend rate of growth in nominal GDP (say 2 per cent inflation, and 2.5 per cent potential real GDP growth).

mortgage approvals

The value of mortgage approvals is quite close to an all-time high. That largely reflects the high level of house prices. But activity in the nationwide house finance market remains very subdued.

A final thought:  it is very rare indeed for serious financial stability risks to develop, in a system with nationwide lenders, when overall lending activity is subdued, and when there is such modest credit growth.  The burden of proof should be on any institution pondering (further) regulatory interventions in the housing finance market, given the inefficiencies such restrictions encourage, and distributional consequences of such measures.