Is inflation finally on the way?
Following one of the world’s most “lowflationary” economic recoveries in history, analysts and economists are beginning to wonder whether fiscal policy is about to kick in and an global inflationary surge could be round the corner, reports Mehreen Khan.
If so, it’s bad news for bondholders (the FT’s Michael MacKenzie explains more here).
Rising prices erode the real value of returns for bondholders. As sovereign yields across the globe plummet to record lows, “clients are increasingly concerned over ‘irrational exuberance’ in fixed income”, warns Michael Hartnett at Bank of America Merrill Lynch.
“Safe, defensive assets are increasingly vulnerable to taper tantum II”, says Mr Hartnett – referring to the chastening drop in bond prices seen when the US Federal Reserve spooked markets in the summer of 2013 by indicating it would start winding down asset purchases.
But herein lies the danger: investors are not yet willing to act on these concerns, says Mr Hartnett. Selling high-grade bonds in today’s environment is “seen as equivalent to selling the irrational exuberance of the Nasdaq in August 1999, eight months before the tech bubble popped”.
The turbocharged rally in sovereign bonds – driven in large by a fresh wave of central bank interventions and persistent fears over insipid economic growth – could quickly reverse, he notes.
But we’ve been here before.
Last year gave rise to the “Bund tantrum” when German government bonds sold off in a punishing reversal having hit record lows. Yet, as fresh monetary easing kicked in at the start of 2016, around 85 per cent of all outstanding German Bunds have fallen into negative yield territory.
So is this time really different? BAML explains some possible triggers for Bond Tantrum II:
- Jackson Hole hawks: the rally in equities and sovereign bonds was sparked by dovish comments from the Federal Reserve’s Janet Yellen back in June, notes Mr Harnett. Later this month, the world’s coterie of central bankers will be gathering for their traditional annual meeting at Jackson Hole. “A hawkish Yellen at Jackson Hole would be the first sign of a risk-off catalyst” he notes.
- Fiscal policy is back: with central banks pushed to extremities on rates and QE, politicians finally seem willing to pick up the baton and help spur growth. Japan is leading the way with tentative moves towards fiscal stimulus, while the UK’s new prime minister is talking up investment over austerity
- “We believe that 2016 and 2017 will likely be seen as years in which the world’s policy-mix shifted from the monetary abundant, fiscally austere mix of the past eight years to a more balanced mix of monetary fine-tuning and easier, targeted fiscal stimulus” adds Hartnett.
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