Now that the markets have convinced themselves about the prospect of inflation...



ref : "Get ready for more bond-market scares" , The Economist, Finance and Economics


Well, you could say that it didn't last long given that things have calmed down over the last couple of days but last week's paroxysm of nerves by investors was just the latest, albeit pretty violent twitch in a condition that has increasingly troubling markets for over 6 months or so .... that of Looming Inflation Anxiety, of course. The recent action was so pronounced that falling bond markets (where inflation worries are most obviously demonstrated) saw the yield on the US 10yr Treasury spike above 1.60 % , and panicky selling spill over into stock markets where the S&P 500 took a big hit.


It's a bit unusual for bonds and stocks to head the same way like that but as so often the wider stockmarket was led by the super-powerful Tech stocks that have done so nicely out of COVID 19. Just as hope of economic recovery is prompting the kind of inflationary concern that damages bond prices (and sends bond yields higher), so it also causes the more flighty investors to get twitchy about sky-high valuations applied to those companies that have done well in the bad times.


There was a time not so long ago, in those blessed pre-pandemic days, when one might have been tempted to wonder whether inflation was ever going to be a problem again in the major economies. That's not to say that people didn't worry about it periodically, but it seemed that no matter how easy the monetary policies adopted by central banks designed to promote consumption and discourage saving, prices stubbornly refused to budge. There have been many reasons put forward as to why that should be so, foremost amongst them the advance of digital commercial practice (much cheaper) and a breakdown in the relationship between levels of employment and inflation (The Phillips Curve, which says that high employment = higher prices). Whatever the case, despite unprecedented (at that time) amounts of stimulus the lack of inflationary reaction saw that US 10yr bond yield -- yes, the one that traded above 1.60% last week -- make an historic low less than a year ago : 0.32% on March 9th 2020


Although it may seem like it , bond prices are not solely about inflation of course. As the Economist points out, falling prices (and rising yields) are natural in economic upturns, just as the reverse is true in the bad times ..... and in those circumstances bond prices would also expect a very significant boost from investors seeking safe havens. But right now, and despite the warnings from scientists not to get ahead of ourselves and to take nothing for granted, it's inevitable that at this stage of the pandemic and the vaccination roll-out investors are looking for a sharp rebound, so in that sense, lower bond prices (and higher yields) are entirely reasonable.


But for sure, inflation anxiety (or lack of it) is going to be key to the demand for bonds and it seems sensible to expect some pretty strong adverse market reactions every time those anxiety levels rise. We have to accept that more than ever some kind of rise seems inescapable : bear in mind the staggering amount of stimulus being poured into economies, and the rising prices of oil and other industrial and agricultural commodities, even if they are dependent on continued production restraint (not always reliable) and Chinese stockpiling. But we've been here, or somewhere quite like it, many times before, and despite all the pointers to the contrary, there is no guarantee that whatever inflation that is headed down the pipeline is going to be of truly problematical levels. It's ironic that some old hands with long memories took years to realise that inflation wasn't going to rise when they thought it should, and are now struggling to get to grips with the fact that it will climb after being "disappointed" so often.


Anyway, how far inflation rises and how damaging that will be is one for the future ..... The Economist's point is that the bond market will be vulnerable to regular and sharp reversals that may or may not be reversed themselves. The problem is that these things to some degree become self-fulfilling : despite the Federal Reserve (say) reiterating their commitment to ultra-easy monetary policy, the market convinces itself that the Fed will have to tighten money market rates earlier than it has indicated, and ultimately take them higher than they have planned ..... cue market jitters. That affects demand for the auction of new Treasury debt, which prompts more selling. And to cap it all, such volatility reduces liquidity which exaggerates the extent of downward moves.. That was the sequence of events last week, and you can see how things can get out of hand.


It doesn't really matter if you subscribe to the theory of galloping inflation or of something more benign, you need to be prepared for a rocky ride .... but then, there'd be nothing new in that.


Well, you could say that it didn't last long given that things have calmed down over the last couple of days but last week's paroxysm of nerves by investors was just the latest, albeit pretty violent twitch in a condition that has increasingly troubling markets for over 6 months or so .... that of Looming Inflation Anxiety, of course. The recent action was so pronounced that falling bond markets (where inflation worries are most obviously demonstrated) saw the yield on the US 10yr Treasury spike above 1.60 % , and panicky selling spill over into stock markets where the S&P 500 took a big hit.


It's a bit unusual for bonds and stocks to head the same way like that but as so often the wider stockmarket was led by the super-powerful Tech stocks that have done so nicely out of COVID 19. Just as hope of economic recovery is prompting the kind of inflationary concern that damages bond prices (and sends bond yields higher), so it also causes the more flighty investors to get twitchy about sky-high valuations applied to those companies that have done well in the bad times.


There was a time not so long ago, in those blessed pre-pandemic days, when one might have been tempted to wonder whether inflation was ever going to be a problem again in the major economies. That's not to say that people didn't worry about it periodically, but it seemed that no matter how easy the monetary policies adopted by central banks designed to promote consumption and discourage saving, prices stubbornly refused to budge. There have been many reasons put forward as to why that should be so, foremost amongst them the advance of digital commercial practice (much cheaper) and a breakdown in the relationship between levels of employment and inflation (The Phillips Curve, which says that high employment = higher prices). Whatever the case, despite unprecedented (at that time) amounts of stimulus the lack of inflationary reaction saw that US 10yr bond yield -- yes, the one that traded above 1.60% last week -- make an historic low less than a year ago : 0.32% on March 9th 2020


Although it may seem like it , bond prices are not solely about inflation of course. As the Economist points out, falling prices (and rising yields) are natural in economic upturns, just as the reverse is true in the bad times ..... and in those circumstances bond prices would also expect a very significant boost from investors seeking safe havens. But right now, and despite the warnings from scientists not to get ahead of ourselves and to take nothing for granted, it's inevitable that at this stage of the pandemic and the vaccination roll-out investors are looking for a sharp rebound, so in that sense, lower bond prices (and higher yields) are entirely reasonable.


But for sure, inflation anxiety (or lack of it) is going to be key to the demand for bonds and it seems sensible to expect some pretty strong adverse market reactions every time those anxiety levels rise. We have to accept that more than ever some kind of rise seems inescapable : bear in mind the staggering amount of stimulus being poured into economies, and the rising prices of oil and other industrial and agricultural commodities, even if they are dependent on continued production restraint (not always reliable) and Chinese stockpiling. But we've been here, or somewhere quite like it, many times before, and despite all the pointers to the contrary, there is no guarantee that whatever inflation that is headed down the pipeline is going to be of truly problematical levels. It's ironic that some old hands with long memories took years to realise that inflation wasn't going to rise when they thought it should, and are now struggling to get to grips with the fact that it will climb after being "disappointed" so often.


Anyway, how far inflation rises and how damaging that will be is one for the future ..... The Economist's point is that the bond market will be vulnerable to regular and sharp reversals that may or may not be reversed themselves. The problem is that these things to some degree become self-fulfilling : despite the Federal Reserve (say) reiterating their commitment to ultra-easy monetary policy, the market convinces itself that the Fed will have to tighten money market rates earlier than it has indicated, and ultimately take them higher than they have planned ..... cue market jitters. That affects demand for the auction of new Treasury debt, which prompts more selling. And to cap it all, such volatility reduces liquidity which exaggerates the extent of downward moves.. That was the sequence of events last week, and you can see how things can get out of hand.


It doesn't really matter if you subscribe to the theory of galloping inflation or of something more benign, you need to be prepared for a rocky ride .... but then, there'd be nothing new in that.

Featured Posts
Recent Posts