Why does an upturn in the economic cycle fail to push up government bond yields?

What Determines the Trend of Government Bond Yields?

Traditionally, the main basis for assessing the trend of government bond yields is market liquidity and economic fundamentals—especially the former. Market participants almost entirely look at how tight or loose market liquidity is, generally taking a liquidity perspective. However, short-term economic cycles are the “anchor” that determines the trend and direction of government bond yields. Changes in liquidity introduce fluctuations on top of that “anchor” (see “When Will Interest Rate Trends Reverse?”). Although market liquidity conditions and economic fundamentals are two important determining variables for changes in government bond yields and serve as independent variables, this does not mean that they do not influence each other.

To a certain extent, liquidity responds to changes in economic fundamentals. Liquidity, in terms of its sources, can roughly be divided into two parts: one is “exogenously” injected by the central bank through monetary policy operations, and the other is “endogenously” created by the economy itself through the bank credit derivation process. Whether the change is “endogenous” or “exogenous,” it is a response to changes in economic fundamentals. For “endogenous” liquidity, economic fundamentals directly affect its changes and determine the direction of movements in funding (money) interest rates. When economic conditions are favorable, market participants are relatively optimistic about the future, and they tend to expand production and investment. At this time, demand for funds is stronger, and an increase in endogenous liquidity creation usually drives funding interest rates higher. When economic conditions are sluggish, market participants’ expectations are correspondingly lowered, and enthusiasm for production and investment declines. At this time, demand for funds falls, endogenous liquidity creation slows, and this is usually accompanied by funding interest rates moving lower.

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