ISMS 4: Bond Yields Are Showing the Fed Has Won Its Battle Against Inflation

Feb 9, 2023

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EM don’t have reserve currency status, unlike DM they never benefited from zero rates

Over the past 12 months, the World average 3mth gov’t bond rate rose from 1.7% to 5.0%
That 3.3ppts rise highlights the rising interest rate environment we have been living through
In the Developed markets 3mth rates rose from zero 12 months ago, before the Ukraine war started, to the current 3.3%
Despite this strong rise, DM’s interest rates remained at a 1.7ppt discount to the world average
Meaning EMs were rising equally fast
So, let’s look at EMs
Over the past year, 3mth rates rose from an already high 4.3% to 7.4%, up 3.1ppts, double the rate of DMs and a 2.4ppt premium to the World average

World LT interest rates rose from 2.8% 12 months ago to 4% today, a 1.2ppts rise
Developed markets saw a YoY interest rate rise from 1.2% to 2.9%, up 1.7ppts rise
DM’s discount to the world interest rates rose from negative 1.6ppts to negative 1.1ppts
EM had a small rise from 5.1% to 5.6% YoY, a small 0.5ppts rise on an already high rate
EM premium to world fell from 2.4ppts to 1.6ppts

EM never had reserve currency status, so unlike DM, they never benefited from zero rates
Since rates have always been higher, borrowers in EMs have not had the same incentive to borrow as in the DMs; therefore, the balance sheet quality is strong

DM Americas rose from 0.2% to 4.7%, up 4.5ppts
Its relative discount to the world narrowed from negative 1.5ppts to negative 0.3ppts

DM Europe rose from negative 0.4% to 2.5%, up 2.9ppts
Its relative discount to the world widened from negative 2.1ppts to negative 2.5ppts
DM Pacific rose from 0% to 1.1%
Its relative discount widened from negative 1.7ppts to negative 3.9ppts

DM Americas rose from 1.8% to 3.4%, up 1.7ppts; rel. discount narrowed from -1% to -0.6%
But LT rates fell slightly in January showing the market believes inflation has been tamed
DM Europe rose from 0.6% to 2.8%, up 2.2ppts; rel. discount narrowed from -2.1% to -1.2%
DM Pacific rose from 0.7% to 1.4%, 0.7ppts; rel. discount widened from -2% to -2.6%

US led the rise, DM Europe is catching up, DM Pacific is now at a deep discount to world rates
DM Europe LT rates rose most aggressively from near zero, preventing a currency collapse
Importantly, LT rates fell slightly in January showing the market believes inflation has been tamed