Is Fiscal Austerity Being Rewarded?
From the IMF to the G20, from bloggers to Nobel prize-winning economists, there have been calls for the major developed countries to reduce deficits and stabilize debt-to-GDP ratios. The idea is that if this is done properly it need not retard growth and the markets will reward countries with lower interest rates, thus reducing the risk premium.
This is an important hypothesis, but so far the evidence is not compelling. In fact, aside from the U.K., those countries that are more aggressively addressing their fiscal excesses are seeing the largest increases in interest rates. And those increases are not simply something that happened earlier this year; they have been occurring in recent weeks.
Ireland, for example, is pursuing some of the most aggressive fiscal policies and yet it's 10-year yield is up 60 basis points in the past month and 107 basis points in the past three months. The two-year yield has risen 41 basis points in the past month and 100 basis points over the past three months.
Spain is also tightening fiscal policy, and its 10-year yield has risen 22 basis points in the past month and 74 basis points in the past three months. It's two-year yield has risen 38 basis points in the past month and 158 basis points in the past three months.
Because the European Central Bank is believed to have been concentrating its bond purchases in Greece and Portugal, we're excluding those two countries from this review.
Germany has unveiled its own plans to reduce its deficit. Over the past month, the 10-year yield is off 8 basis points and over the past three months the yield has fallen 49 basis points The two-year yield has risen 17 basis points over the past month and is off 28 basis points over three months.
Compare these performances with debt of the the U.S., which seems strikingly behind Europe (and Japan) in laying out a deficit-reduction strategy. Over the past month, the U.S. 10-year yield is off 9 basis points and 94 basis points in the past three months. The U.S. two-year yield is off 15 basis points in the past month and 44 basis points in the past three months.
In this review of the bond market performances, it does not appear that those countries that are cutting deficits are being rewarded with lower interest rates. The U.S., which many perceive as a profligate spender, has seen its yields decline more than more austere countries.
The U.K. appears to stand out as an exception. Over the past month, its 10-year yield has fallen 22 basis points, while the two-year yield has fallen 14 basis points. A hypothesis that would explain the U.S. and U.K. performance is the reserve status of the dollar and sterling. Agreed, this was not picked up in the first-quarter COFER data out yesterday, but both bond markets appear to be drawing support from a flight out of continental Europe.
