Grant's Interest Rate Observer.

Ich bin ein bond bear

Last Friday’s release of German CPI for December surprised with a 1.7% year-over-year uptick, against the consensus of 1.5%.  That pushed the average year-over-year rise in consumer prices at 1.8% for 2017, far above 2016’s 0.5% average and the 0.3% seen in 2015.   Strip out energy prices, and 2017’s 1.6% mean compares to 1.2% over the prior two years.

Holders of 10-year German government bonds, which currently fetch a 0.47% nominal yield and a negative 1.2% real one, continue to show no evident concern.  As CPI inflation pushes higher, borrowing costs hold steady.

Amid that modest but visible inflationary onset, the bond market’s ace in the hole may not stick around for too much longer. In an interview last week with Caixin Global, the European Central Bank’s Benoit Coeure hinted that the central bank is considering an exit: “Given what we see in the economy, I believe that there is a reasonable chance that the extension of our asset purchase program decided in October can be the last.”

At the tail end of the 1946-1981 bond bear market, investors increasingly referred to Treasurys (which featured, by the end of 1982, a 10.4% nominal yield on the 10-year note against 3.8% year-over-year CPI inflation) as “certificates of confiscation.”  That phrase has been understandably mothballed in the intervening decades.  In the case of German 10-year sovereigns, we say it’s time to take it out of layaway.