Week End Blog – Goodbye Greece, Hello Bond Bubble!

It took a while, but Greece no longer dominated all the headlines this week. The Greek government handed in a ‘to-do list’ that was enough for Mr. Dijsselbloem to work with. The bailout extension was approved and everything went back to normal. Greek bond yields came down sharply and all markets rallied. Who remembers Greece? Another striking example of the short-term nature of financial markets.

But Greece could come back with a vengeance. Morgan Stanley provided a nice timeline which shows there are still many issues left that could cause market turmoil. The ECB decision on ELA, multiple Eurogroup meetings, and looming redemptions are just a few of them.

With Greece ‘out of the way’, markets focused on the main topic of before. Lowflation! This graph by The Economist neatly summarizes the global trend in inflation levels. There are few countries left where inflation is not going down.

This week, the United States also entered the world of deflation. While only just, and, like in many countries, from a headline perspective, they did enter. That’s worth a tweet or two since deflation in the US has become pretty rare during the last decades.

Inflation is no exception in Japan. Quite the opposite. Inflation numbers above 2% are very rare. In January inflation levels remained above the 2%-threshold, but they probably won’t stay there. Expectations are that inflation falls back to just 1%, leaving Kuroda puzzled after all his efforts to drive up consumer prices (and wages.)

Inflation worries mean lower interest rates. Add the ECB buying a huge chunk of government bonds in the Eurozone and you know where yields are heading in this region. Germany’s 10-year bund yield hit another all-time low. You now have to pay a fee for holding bonds with a maturity up to seven years.

Yields on bonds of peripheral countries like Italy and Portugal decreased even more than those on German bonds. As mentioned, Greece is forgotten easily, as spreads contracted massively. Italian bonds have rallied more than 50% since the beginning of 2012. Another sign that we are in the mother of all bond market bubbles. Please correct me if you think I’m wrong.

That bubble may not pop for quite some time, however. Ultra flat (or even negative) yield curves usually occur when central banks increase short-term rates aggressively to push down growth and inflationary pressures. However, with many short-term yields already negative (although even more negative is possible as Switzerland proves) the focus has shifted to longer-term bonds. Could extreme loose monetary policy have the same result as tight monetary policy?

More flattening is likely in the United States. Fed boss Yellen reiterated that the Fed will take a cautious approach and that a rate hike will not happen in the first couple of meetings to come. However, she also noted that a rate hike is definitely on the table if the data allow it.

Political tensions in Europe continue to linger, even though an immediate exit of Greece is avoided. Especially in the Ukraine things look tense. The cease-fire is shaky and signs that Ukraine’s economy has collapsed are getting clearer. The Ukrainian hryvna remains under severe pressure and very little is needed to make things worse.

With Russia also under severe pressure things aren’t looking that bright for currencies of other former Soviet States as well.

Two items to round up this Week End Blog. First, Max Roser (@MaxRoser) tweeted this great graph showing the number of equations in economic papers is steadily rising. Which raises the obvious question: Are we getting smarter of do we make thing too complex, nowadays?

Second, we had the thing with ‘The Dress.’ Is it blue and black or gold and white? The discussion went completely viral (strange things happen on Twitter sometimes). Anyway, I’ll let you judge yourself.

Enjoy your Weekend!





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