Expert Commentary

Kiss Goodbye to Low Yields & Say Hello to Debt Deflation

Here is more evidence that bond yields are basing.

The incredible era of ultra-low interest rates and bond yields could be in the process of changing, judging by the chart of the German 10-year government bond. The Bund yield fell from 4.70% in 2008 to a low of minus 0.91% in 2020. As it did so, a distinct trend channel was formed, as shown below. The sideways movement in the yield over the past eighteen months has resulted in the yield moving out of the channel, and in the second quarter of this year the Bund looked like it might break back above 0%. That was not to be, but the subsequent decline might be giving us an excellent clue that the bond environment is changing.

In technical analysis, when a trendline or previous level of support or resistance is broken, the price often retraces back towards that area, only for it to now hold in the opposite direction. It is as if the price comes back to the previous level to give it a kiss goodbye before trending in a new direction. When old resistance becomes support or vice versa like this, it is normally a very good sign that psychology has shifted. Judging by the chart, it looks like the upper channel line in the previous multi-year downtrend in the Bund yield has acted as support.

Does this mean that we should expect the Bund yield to rocket higher? No. Indeed, previous experience tells us that the trendline might be tested again and so patience is required. Nevertheless, it is certainly worth noting because of the ramifications.

When bond yields start to rise again, it will become incredibly difficult for heavily indebted nations and corporations to manage their debt burden. Prudent Germany, of course, should manage better than others, but rising interest rates and bond yields will be a nightmare for the likes of Italy and Greece, to name but two sovereigns in Europe alone. With global private sector debt at record highs, a return to a higher interest rate environment also has the potential to cause widespread debt deflation.

German Bund 10-Year Yield- September 2021