17 Jun

2015

Research Briefing

Global Outlook
Bond Tantrum II: the possible consequences
The recent sharp rise in global bond yields has much in common with the early phase of 2013s taper
tantrum especially the sharp rise in the term premium. Using the Oxford Global Economic Model, we
examine the possible consequences of the rise in yields extending into a Tantrum II.
A further rise in the term premium in advanced economies of around 50 basis points (taking it toward its long-term
average) would be likely to induce sharp rises in yields in emerging markets as well. As a result, the overall impact
of a Tantrum II scenario could be a significant hit to world GDP.
We can get an insight into just how serious the impact of an extended and widespread rise in global yields might be
using the Oxford Global Economic Model. In our scenario, global GDP growth is around half a point weaker in 2016
and 2017 than in our baseline forecast.

Yields rise as term premium jumps

In recent weeks, as global bond yields have come under
upward pressure, we have outlined possible downside
risks to global bond yields from factors such as the
slowdown in China and the risk of Grexit.
But in our view there are also upside risks, which if they
materialise could see the recent rise in global bond yields
extend considerably further. In such a scenario, we could
see a similar pattern in yields to that seen in 2013s socalled taper tantrum.

US: Decomposition of bond yields

%
3.5

Fitted 10-year
yield

3.0
2.5
2.0

Risk neutral
yield

1.5
1.0
Term premium

0.5
0.0
-0.5
-1.0
2012

2013

2014

2015

Source : Federal Reserve Bank of New York

A key factor behind both the 2013 bond market tantrum

and the recent rise in 10-year yields has been a sharp

rise in the term premium (the extra yield investors

demand for holding a long-term security rather than a
series of shorter-term ones). Indeed, in both periods the
risk-neutral yield (an estimate of what the 10-year yield
would be if investors were indifferent to risk) moved little.
For the US, the term premium has increased by around
60 basis points (bp) since late March.

and still upside risks to yields

The reasons for this rise in the term premium are not
entirely clear. Normally, the term premium is thought to
be related to levels of uncertainty about future interest
rates or inflation. Available survey measures of these
factors have increased only moderately, though,
suggesting other factors may be at work. Some of the
rise may simply be down to mean reversion, especially
as the big fall in the term premium in 2014 was also hard
to associate with traditional drivers such as uncertainty.
If there is a mean reversion element in play this already
suggests some further upside risk as the term premium
remains well below its historic average levels. Currently,
it stands at around 30bp but the long-term average (since
1993) is around 130bp.
Comparison with the 2013 episode also implies some
upside risks. In May-August 2013, the estimated 10-year
term premium rose by 140bps, from close to zero to
around its long-term average level.

Economists: Adam Slater, Lead Economist | Tel: +44 1865 268934 | e-mail: aslater@oxfordeconomics.com

17 Jun
2015

Research Briefing
Looking back to 2013, it was notable that the ultimate rise
in yields in several emergers was much larger than in the
advanced economies: Indonesia, Turkey and Brazil saw
rises in excess of 300bp.

US: Two 'tantrums'

Estimated 10-year term premium, %
2.0

1.5
2013 May-August
1.0
140bp
from t

A repeat of this pattern is a genuine risk: emerging bond

markets are often less liquid than their advanced
counterparts, and so more prone to violent price moves
when selling pressure starts.

0.5

Emergers: 10-year yields

% point change

60bp
from t

0.0

Indonesia

2015 March-June
-0.5
t-60

Turkey
Poland

t-40

t-20

t+20

t+40

t+60

t+80

Source : Oxford Economics/Haver Analytics

Another important potential factor is the impact of

quantitative easing (QE). A number of studies have
suggested QE may have compressed the US term
premium by around 100bp (e.g. by reducing uncertainty
about the path of future interest rates), so should this
start to unwind there would be considerable potential
upside to yields.
On the face of it, this should not be an immediate threat
as the US Feds bond holdings remain very large and
have not yet begun to be cut back. However, there is a
danger that as the Fed moves towards rate rises in
September investors may associate the move to rate liftoff with an early unwinding of the Feds Treasury
holdings. This appears to have been a factor behind the
1
sharp rise in the term premium in 2013 the scale of
which caught the Fed by surprise.
Another factor that could add to upward pressure on
yields is the reduced level of liquidity in bond markets
compared with a few years ago, a result partly of
changes in regulation. This factor is likely to have already
contributed to volatility of global yields over recent weeks.

Australia
Hungary

Apr 1-Jun 15

S.Africa
Q1-Q4 2013

Thailand
Korea
Malaysia

Brazil
India
China
-1.0

0.0

1.0

2.0

3.0

4.0

Source : Oxford Economics/Haver Analytics

Moreover, rising yields in the advanced economies tend

to divert capital away from emerging markets, draining
liquidity and sometimes forcing up the entire term
structure of interest rates. Recent data on portfolio flows
to emerging markets seem to confirm that something of
this kind is going on: the IIF portfolio flows tracker for
emerging markets for May saw net inflows plunge to just
US$7.1 billion only a quarter of Aprils flows with net
outflows from debt instruments.

Emerging markets: Portfolio flows into debt

US$bn
40

Emergers could be hit hard

30

While most recent attention has focused on the rise in

bond yields in the Eurozone and the US, yields have also
been on the increase in the rest of the world too and in
some cases to a greater extent than in the advanced
economies. There have been increases in 10-year yields
of over 100bp in Turkey and Indonesia, and a near-90bp
rise in Poland. In Australia, yields have surged by 75bp.

20
10
0
-10
-20
2010

2011

2012

2013

2014

2015

Source : IIF
1

See T.Wu Unconventional Monetary Policy and Long-Term

Interest Rates IMF Working paper WP/14/189

Economists: Adam Slater, Lead Economist | Tel: +44 1865 268934 | e-mail: aslater@oxfordeconomics.com

17 Jun
2015

Research Briefing

with world growth cut 0.4% pa in 2016-17

We can get an insight on to just how serious the
consequences of an extended and widespread rise in
global bond yields might be using the Oxford Global
Economic Model.
The model allows us to propagate an upward shock to
yields across the world, with the scale of the increase in
yields relating to the credit rating of each country (a proxy
for vulnerabilities related to liquidity and foreign outflows
noted above and also for risk off effects i.e. investors
moving most aggressively out of the riskiest markets).
Our scenario assumes that the term premium in the
advanced economies (US, Europe, Japan and Canada)
rises (permanently) by a further 50bp, pushing yields up
above baseline levels by a similar amount. This rise is
triggered from Q3 2015 onwards as the US Fed begins
tightening policy, with the Fed move triggering a spike in
uncertainty about the future path of monetary policy.
% point difference from base, Q3 2016
Hungary
Turkey
Indonesia
Brazil
S.Africa
India
Poland
Thailand
Malaysia
China
Korea
Germany
US
Japan
UK
Australia
Canada
0.5

1.0

1.5

Our scenario leads to increased yields across emerging

market countries also. The rises are relatively modest in
more developed markets such as Korea and also in
controlled markets such as China, at under 100bp by Q3
2016. But 10-year yields rise by around 150bp in
Malaysia over the same time period, Poland and
Thailand, 180-230bp in India, South Africa, Brazil and
Indonesia and over 250bp in Turkey and Hungary.
These increases are not dissimilar in scale to some of the
outcomes observed in 2013. The overall impact of the
initial bond market disturbance in the advanced
economies is a considerable global monetary tightening
considerably aggravated by some of the sharp rises in
yields seen in the emerging markets. The impact of this
on global growth is significant. In our scenario, world
GDP rises by 2.7% in 2016 and 2.8% in 2017 versus
3.0% and 3.2% in the June baseline. So in this scenario,
around a half a point is cut from global growth in each of
these two years.

World: Yields in 'Tantrum II' scenario

0.0

We assume the Fed continues on the same rate hike

path as in our baseline scenario until Q3 2016, which
involves a total of four 25bp rate increases. After this
point, US short rates are allowed to adjust to the weaker
growth and inflation picture resulting from the scenario.
This leads to a slower path of rate increases than in the
baseline (Fed rates are about 50bp lower at end-2017 as
the Fed slows hikes in response to the slower growth
induced by higher long-term yields), dampening some of
the negative impact of the scenario on growth.

World: GDP in 'Tantrum II' scenario

2.0

2.5

3.0

Source : Oxford Economics/Haver Analytics

US: Federal Funds rate

%
6
5
Baseline
4
3
2

% difference in GDP from base

Canada
Australia
Japan
UK
2016
USA
2018
S.Africa
Korea
Eurozone
China
Malaysia
Thailand
Poland
Hungary
Brazil
Turkey
Indonesia
India
-3.5

-3

-2.5

-2

-1.5

-1

-0.5

Source : Oxford Economics/Haver Analytics

Scenario

1
0
2005

2007

2009

Source : Oxford Economics

2011

2013

2015

2017

GDP is around 0.6% lower than in the baseline in the US

by 2018, and around 1.2% lower in Japan. But the
biggest losers are among emerging markets. Emerging
market growth drops to 4.1% in 2016 and 2017 versus

Economists: Adam Slater, Lead Economist | Tel: +44 1865 268934 | e-mail: aslater@oxfordeconomics.com

17 Jun
2015

Research Briefing

4.4% and 4.7% in the baseline. In some key markets

Brazil, Turkey, Indonesia and India GDP is 2.5-3%
below baseline by 2018, reflecting both the scale of the
yield rises and their sensitivity to higher interest rates.

Conclusion
Although the recent rise in yields in the US and the
Eurozone has an element of healthy correction about it,
there is a risk that it could extend into something more
economically damaging.
In particular, there is great uncertainty about how much
higher the term premium embodied in long-term rates
may rise. The term premium remains low by historic
standards and compared to the levels reached in the
2013 taper tantrum. A correction towards those levels
could be sparked by greater uncertainty about the future
path of monetary policy (or inflation), with this risk
perhaps increased by the large gap between Fed
projections of the future path of short rates and those in
the market. Such a correction (if sustained) could see 10year yields jump as much as 50-100bp, with potentially
even larger knock-on effects on emerging markets.

Economists: Adam Slater, Lead Economist | Tel: +44 1865 268934 | e-mail: aslater@oxfordeconomics.com