Why the US bond market matters

Felix Martin's "Real Money" column.

On 22 May, Ben Bernanke, the chairman of the board of governors of the US Federal Reserve, made what must have seemed to innocent observers an innocuous remark: he suggested that the era of nearzero interest rates in the US could not last for too much longer and that the Fed might begin to wind down its policy of quantitative easing (QE) later this year.

The reaction of the world’s financial markets was swift and dramatic. First, the interest rate on US government bonds jumped. Then the world’s currency markets went haywire. The US stock market battled on for a few more weeks before it, too, took fright and embarked on a precipitous descent.

People who are not finance professionals might be forgiven for asking what all the fuss is about. Why, after all, should these inconsequential remarks matter so much – and so what if the interest rate on US government bonds rises by a mere 1 per cent? Is any of this relevant to normal people who don’t spend their time buried in the back pages of the Financial Times? The answer, unfortunately, is yes.

The government bond market is the axis on which the financial system of every modern, capitalist economy turns. The interest rate at which the government can borrow is the most important price in the economy – the one on the basis of which the price of every other financial asset and, indirectly, all other prices and wages are set.

Companies and individuals pay interest rates on their borrowing at rates set as a markup over the government’s rate. So if the UK government can borrow for a term of ten years at 2 per cent, then a financially robust and well-established company might be able to borrow at 3.5 per cent; and a flightier, less well-capitalised, more speculative one might be able to borrow at, say, 7 per cent. You or I, meanwhile, might be able to borrow at an even higher rate than that. When the interest rate the government pays moves, so do all the others. Thus, the interest rate on government bonds affects the entire economy.

In this matter, as in so many others, the US is more important than every other country. It is not just that the interest rate on US government bonds is the reference point for the largest economy in the world. The US dollar is also the world’s de facto reserve currency – it’s the only currency that almost anyone anywhere is ready to accept and so everybody wants to keep a precautionary store of it.

As a result, US interest rates filter through to the entire international economy as well. The US dollar is the primary currency of international finance – so that when the interest rate on US government bonds goes up, it becomes more costly not only for the US treasury to borrow at home but also for any government, company or individual almost anywhere in the world to borrow from abroad. Nor is that the end of the story. The differential between the interest rates on government bonds in different countries is a key determinant of exchange rates.

All other things being equal, if the interest rate on the US government’s bonds rises when the interest rate on the British government’s bonds remains unchanged, investors will try to rebalance their investments towards US bonds and away from British ones. As they do so, they will drive down the value of the pound sterling relative to the US dollar.

Even small changes in the interest rate on US government bonds can have a big effect on the relative value of currencies in this way – especially in the emerging markets. In the few weeks since Bernanke made his remarks, the currencies of Mexico, South Africa and Brazil, for example, have all lost more than a tenth of their value against the US dollar. This is extreme volatility of exchange rates and it can be highly disruptive of international trade and finance.

In short, the interest rate on American government bonds is the single most important regulating factor in the world economy. It’s no wonder that James Carville, Bill Clinton’s electoral strategist, reflected ruefully in 1993, “I used to think if there was reincarnation, I wanted to come back as the president or the pope . . . but now I want to come back as the bond market. You can intimidate everybody.”

So is it a good or a bad thing that US interest rates are on the rise following Bernanke’s recent pronouncements? It used to be easy to answer to that question. The link between the central bank policy or base rate and government bond yields was simple. When the economy was in rude health, the central bank would hike its policy rate and the interest rate on government bonds would rise; and when the economy was running out of steam, it would cut and bond yields would fall. Higher rates meant a healthier economy.

Since 2009, however, this transparent link between the bond market and the central bank has evaporated. With central bank policy rates stuck at zero, the bond market has had to take its cue not from monetary policy itself but from officials’ speeches and journalists’ scoops. The utterances of central bank officials such as Bernanke have become major economic data in their own right. The medium has become the message.

The result has been to turn investing in government bond markets into a kind of monetary Kremlinology, in which every passing comment of central bankers is minutely parsed for clues to the true direction of policy. In June, the new Kremlinologists concluded from Bernanke’s latest oracle that the global economy was in robust enough shape to tolerate a rise in the all-important interest rate on US government bonds.

For all our sakes, we had better hope that the divinations of the new Kremlinologists turn out to be more accurate than those of the old ones.

Traders work on the floor of the New York Stock Exchange. Photograph: Getty Images

Macroeconomist, bond trader and author of Money

This article first appeared in the 01 July 2013 issue of the New Statesman, Brazil erupts

ELLIE FOREMAN-PECK FOR NEW STATESMAN
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The triumph of Misbah-ul-Haq, the quiet grafter

How Misbah redeemed Pakistani cricket.

It was an incongruous sight: the entire Pakistani cricket team doing press-ups on the revered pitch at Lord’s, led by its captain, Misbah-ul-Haq. This unusual celebration marked not merely a Test match victory over England on Sunday but something greater: the rehabilitation of Pakistani cricket.

Seven years earlier, the Sri Lankan team bus was en route to the cricket stadium in Lahore for the third day of a Test match against Pakistan when it was attacked by Islamist militants. Gunfire killed six police officers and a driver; several Sri Lankan cricketers were also injured. That was the last Test match played in Pakistan, which, despite protestations, opponents consider too dangerous to visit.

A year later, Pakistan toured England for a Test series. The News of the World alleged that in the final match at Lord’s three Pakistani cricketers had conspired to bowl no-balls in exchange for money. All three received bans of five years or more for corruption. The entire squad was lampooned; police had to shield its members from abuse as they arrived home.

Misbah was on the periphery of all of this. Aged 36 at the time, he was dropped from the squad before the English tour and seemed unlikely to play international cricket again. But the turbulence engulfing Pakistani cricket forced the selectors to reassess. Not only was Misbah recalled but he was made captain. “You have to ask yourself,” he later said: “‘Have I been the captain because they supported me, or because they had no alternatives?’”

Pakistani cricket prizes and mythologises teenage talent plucked from obscurity and brought into the international side. During his decade as captain, Imran Khan picked 11 teenagers to make their debuts, often simply on the basis of being wowed by their performance in the nets. Misbah shows that another way is possible. He grew up in Mianwali, a city that was so remote that: “The culture there wasn’t such that you thought about playing for Pakistan.”

At the behest of his parents, he devoted his early twenties not to his promising batting but to gaining an MBA. Only at 24 did he make his first-class debut, strikingly late in an age when professional sportsmen are expected to dedicate all their energy to the game from their teenage years.

Pakistani cricket has always been “a little blip of chaos to the straight lines of order”, Osman Samiuddin writes in The Unquiet Ones. Misbah has created order out of chaos. He is unflappable and methodical, both as a captain and as a batsman. His mood seems impervious to results. More than anything, he is resilient.

He has led Pakistan to 21 Test victories – seven more than any other captain. He has done this with a bowling attack ravaged by the 2010 corruption scandal and without playing a single match at home. Because of security concerns, Pakistan now play in the United Arab Emirates, sometimes in front of fewer than a hundred supporters.

Misbah has developed a team that marries professionalism with the self-expression and flair for which his country’s cricket is renowned. And he has scored runs – lots of them. Over his 43 Tests as captain, he has averaged at 56.68. Few have been so empowered by responsibility, or as selfless. He often fields at short leg, the most dangerous position in the game and one usually reserved for the team’s junior player.

Misbah has retained his capacity to surprise. As a batsman, he has a reputation for stoic defence. Yet, in November 2014 he reached a century against Australia in just 56 balls, equalling the previous record for the fastest ever Test innings, held by Viv Richards. The tuk-tuk had become a Ferrari.

Late in 2015, Misbah tried to retire. He was 41 and had helped to keep Pakistani cricket alive during some of its darkest days. But the selectors pressured him to stay on, arguing that the team would need him during its arduous tours to England and Australia.

They were right. His crowning glory was still to come. The team arrived in England following weeks of training with the national army in Abbottabad. “The army people are not getting much salaries, but for this flag and for the Pakistani nation, they want to sacrifice their lives,” Misbah said. “That’s a big motivation for all of us. Everyone is really putting effort in for that flag and the nation.”

Now 42, almost a decade older than any cricketer in England’s side, Misbah fulfilled a lifetime’s ambition by playing in a Test match at Lord’s. In Pakistan’s first innings, he scored a century and celebrated with push-ups on the outfield, in homage to the army’s fitness regime and those who had had the temerity to mock his age.

When Pakistan secured victory a little after 6pm on the fourth evening of the game, the entire team imitated the captain’s push-ups, then saluted the national flag. The applause for them reverberated far beyond St John’s Wood.

“It’s been a remarkable turnaround after the 2010 incident,” Misbah-ul-Haq said, ever undemonstrative.

He would never say as much, but he has done more than anyone else to lead Pakistan back to glory. 

Tim Wigmore is a contributing writer to the New Statesman and the author of Second XI: Cricket In Its Outposts.

This article first appeared in the 21 July 2016 issue of the New Statesman, The English Revolt