The US Federal Reserve (the Fed) is shrinking its balance sheet this year by not replacing some of the maturing bonds in its portfolio. However, central banks in Europe and Japan continue to print record amounts of money to purchase bonds. Consequently, global central bank balance sheets may expand this year from $21.3 trillion to $24 trillion.
The changing size of central bank balance sheets (or global currency levels) combined with the amount of transactions (or velocity of money) can greatly affect global economic growth. Currently both are expanding, forecasting stronger global growth.
In order to restrain inflation, the Fed raised overnight interest rates from 1.25% to 1.5% last month. Interest rates on the US three-month Treasury bill, two-year note and ten-year bond have risen (to 1.7%, 2.27% and 2.74%).
The two and ten-year Treasury rates are closely watched by some investors as an inverted yield curve (i.e. when ten-year rates are lower than two-year rates) can portend a recession and bear market in 6 to 18 months. Some bears state that today’s 0.47% point difference in yield between those two bonds is too narrow, despite all Treasury interest rates being less than 3%.
Similar to the effects from printing money, low interest rates can boost economic growth. Following this principle, the European Union (EU) and Japanese central banks still maintain negative overnight interest rates. Due to the EU’s and Japan’s central banks ongoing money printing to buy bonds, the effective interest rates on the German and Japanese five-year government bonds are negative (about -0.1%).
Less credit worthy countries have been able to take advantage of investors’ desire for higher interest rates by issuing new bonds. Argentina, Kenya and Nigeria have already issued dollar-denominated bonds this year. Others, like Bahrain, Oman and Sri-Lanka may follow suit. Short-term, this should help the governments and economies of these nations. Long-term, emerging market bond investors could lose money if/when these countries default on their obligations