What Happens When $365trn Meets Higher Rates?

Tresmark: Imagine sitting in a courtroom as the judge reads out a sentence:

– US 10Y: 5.04%, highest since 2007
– Germany 10Y 3.62%: 17-year high
– Japan 30Y 4.15%: 30-year high

Of 16 major central banks we tracked over August and September, five raised rates, with more to follow.

So what if global yields are going up? $365trn

This is the rough number for global debt. But perhaps the more interesting number is $3.3trn. That is how much advanced economies spent last year just paying interest on internationally traded government bonds.

Now imagine if the interest rates move up ….

Note: Higher yields don’t reprice the entire debt stock overnight.

Pain in Bond markets

Why is there so much pain in the bond markets? Inflation, Oil and CB hikes explain part of the bond selloff. But not all of it.

WSJ reported this week that some of the latest move appears to have been driven by forced selling or hitting stops.

Selling → higher yields → more losses → more selling.

The bond market may be starting to feed on itself.

Why Japan matters

For decades, Japan was one of the anchors of cheap global money. Now Japan’s bonds are at 30-year highs.

One of the world’s great suppliers of cheap capital may slowly be changing sides.

The Bond Paradox

What happens if the bond selloff gets out of control? Normally, CBs can provide liquidity. But doing that while they are simultaneously trying to contain inflation creates its own problem.

The Fed, ECB and BoJ are currently doing almost the opposite. They are fighting inflation.

So CBs could eventually face a rather uncomfortable choice:

Fight inflation by raising rates and risk fuelling a further selloff in bonds
Or
Fight financial instability by providing cheaper liquidity and risk adding to inflation

October could be a very volatile month.

PKR Outlook

The Rupee’s near-term outlook remains heavily influenced by fuel costs and therefore developments in the Iran-US war. With some thaw witnessed last week, there is renewed optimism that fuel costs could continue to decline. This would strengthen the stable Rupee trade, although we would be slightly more cautious selling exports beyond the 3-month tenor.

Forward premiums got jolted last week as SBP did not roll over its maturing swaps, pushing shorter tenors into negative territory. Banks, however, are still offering healthy spreads over prevailing forward rates to lock in future inflows.

Our favoured trade remains to sell exports forward within 3 months, while becoming more cautious beyond that. In the 3-6 month tenors, exporters may selectively hedge on a case-by-case basis.

Pakistan’s Dilemma

Pakistan can manage its domestic inflation. It can build reserves. It can manage the CAD. It can even keep PKR remarkably stable.

What it cannot set is the global price of money.

And that leaves us with perhaps the most important question for SBP: What is the appropriate Pakistani interest rate when the world’s risk-free rate itself is being repriced?