What is cause and what is effect? Our perceptions are shaped by our physical experiences, which are described by Sir Isaac Newton, with observable actions producing predictable reactions. Newton formulated the laws of motion that govern the physical world in which we operate.
There is another world that we don't inhabit, where the familiar relationship of cause and effect breaks down. That is what happens to Newtonian physics when its properties are applied to subatomic particles or to the universe with objects that approach the speed of light. While I have studied quantum mechanics, I cannot pretend to comprehend the system. Perhaps God whispered in the ear of the Albert Einstein to explain how it all works.
In any case, it is beyond my ken. These questions mainly have forced me to question my assumptions about the simplistic causality of human events, especially as it applies to economics and finance. That runs counter to the high priests of those disciplines, who require models to be built on the mathematics of Newton -- as if the behavior of humans followed the laws of motion like billiard balls.
Apologies, then, for this long-winded lead-in for the matter at hand, the simultaneous surge of bond yields in the U.S. and Japan. Yields have shot up sharply in the past few days -- while the central banks of both nations have been buying bonds in huge amounts to lower long-term interest rates. Yet, precisely the opposite is happening.
What's most puzzling is whether the rise of U.S. Treasury yields -- spurred by the expectations that the Federal Reserve will trim its bond purchases -- is driving yields of Japan government bonds higher. Or is it the other way around: that the jump in JGB yields is rippling through global bond markets and is pushing yields on other government bonds higher?
There are adherents to both sides of the argument. And, as usual, where you stand may depend upon where you sit.
Pimco's Bill Gross (who needs no further introduction, but to be formal, is the chief investment officer and co-chief executive of Pimco, as well as member of the Barron's Roundtable) thinks the rising wave of bond yields travels from Japan to the U.S. He tweeted to is myriad followers: "What hath Kuroda wrought? JGB yields a bigger influence on Treasuries than tapering potential." The reference is to Haruhiko Kuroda, the governor of the Bank of Japan, which has embarked on a huge program of bond buying designed to double the nation's monetary base -- currency and bank reserves, or so-called high-powered money -- and thus produce a similar rise in the money supply and then, in turn, to generate a similar expansion in Japan's gross domestic product. Note the Newtonian script of action and reaction; BOJ bond purchases expand bank reserves, which increase the money supply and thus the economy.
If that is how things work, higher Japan government bond yields cause declines in their prices and force global investors to sell other assets to cover losses, especially for margin loans. The surge in Treasury yields to 14-month highs with the benchmark 10-year note hitting 2.17%, reflects the gravitational pull of rising Japanese government bond yields. Which makes sense if one accepts that the ascent of global asset prices -- notably U.S. equities -- owes much to the liquidity expansion by the JGB, which seeped abroad by boosting stock and bond prices in other markets.
By contrast, Uwe Parpart, the head of research for Reorient Research in Hong Kong, sees the causality running in the opposite direction. Suggestions from Bernanke that the Fed could rein in its bond purchases at some point have precipitated a sharp sell-off in Treasuries and JGBs as well. As the benchmark 10-year U.S. Treasury yield climbs beyond 2%, a sub-1% 10-year JGB looks mispriced -- especially in the context of a rising dollar and falling yen vs. the dollar.
So, who is right: Pimco's Gross or Reorient's Parpart? I am agnostic in the face of conflicting signals. My inference is that both central banks have less influence on their respective bond markets than they want to believe. Their money printing, which is supposed to drive down bond yields, is having the opposite effect.
Central banks delude themselves into thinking they are in charge; that they can control events in a deterministic, Newtonian fashion. But unintended consequences are emerging, notably a rise in long-term interest rates. That will change the calculations for a a whole slew of assets that are deemed cheap mainly when compared with Treasuries.
Comments? E-mail: firstname.lastname@example.org