Where do you find a good yield?

Charles Stanley

Part of the big idea of Central Banks creating money and buying bonds is to drive other investors to buy riskier assets. They want to stimulate more activity. They hope that by taking interest rates down to very low levels some people will spend more instead of saving, and others will be more adventurous with their savings.

For the markets as a whole, as the Central Bank buys up more and more of the supply of government bonds, so investors have to switch to having more invested in shares, property and other riskier assets. This creates the hunt for yield, as savers look for some higher income instead of keeping cash on deposit or lending their money to the government.

Japan, the Eurozone and the UK still want there to be more growth, and are still pursuing aggressive programmes of bond buying. This week the European Central Bank has just passed a milestone. It now owns more than €1 trillion of bonds. Given the way these huge buying programmes can create scarcity even in the relatively well populated government bond pools, the central banks are spreading out some of their buying into riskier assets themselves. The UK and the Eurozone authorities are buying some corporate bond paper. In Japan they are also buying exchange-traded funds that own shares.

All these moves serve to raise the prices of financial assets above the level they would reach without this artificial support and stimulus. Some market participants seek to buy these assets in advance of the central banks, to make an extra return from the gains they expect as such a large buyer emerges.

No-one, including the central banks, can be sure how long this will continue or whether in due course we have to return to the old normal where the authorities did not create money to buy up their own debt and other people’s assets. It is true that the US has weaned itself off money creation and is enjoying a moderately-paced recovery without further artificial stimulus. The UK too had reached that point before the Bank decided it wanted to do some more quantitative easing as it feared a decline in confidence following the EU referendum.

Markets will rightly remain very attuned to every word and whim of the central bankers.

The idea behind official buying is to give time for the usual credit-creating commercial banks to rebuild their balance sheets and to resume financing growth without unusual central bank interventions in asset markets. US banks are now able to finance a recovery. UK money growth and credit growth was financing a modest recovery and was just accelerating at the very point where, strangely, the Bank of England decided it needed to resume special measures. In Japan and the Eurozone it has taken longer to get satisfactory rates of commercial credit growth, given some weak bank balance sheets and an older declining population in Japan and parts of Europe.

Markets will rightly remain very attuned to every word and whim of the central bankers. They have come to take an ever more prominent role in the world’s financial markets. They have decided on ultra-low interest rates, pushing more people to take more risk with their money. They have become huge owners of bonds and in the case of Japan are now becoming an important owner of shares. They have often stopped markets falling, and have sometimes created strong bull runs in what used to be dull old bonds. The modern financial world is based on very low interest rates and big participation by the authorities as owners and buyers as well as supervisors and rate fixers.

It looks as if the Japanese and European authorities still want to do more to sustain their elevated bonds. The UK may not need to extend its latest programme but is clearly in no hurry to raise interest rates. That is why market participants pore over every word and raised eyebrow from the Fed in the US. Their reluctance to raise their rates allows the bond party to continue. We have assumed that will be the case. If they change their mind and end their lower rates for longer approach it may require some rethinking.


The above article by John Redwood, Charles Stanley’s Chief Global Strategist, was first published by Charles Stanley on 6th September 2016.