These macro musings are not intended to be a running commentary on rising bond yields, but the subject is difficult to avoid while the wind is firmly behind them. As we write, the US 10 Year Treasury yield is nudging 1.5% having been 0.3% 11 months ago; this week the French 10 Year sovereign yield has gone from negative to positive, leaving in the eurozone only Germany and the Netherlands with negative yields (two months ago, those with negative yields in Europe also included Portugal and very briefly Spain, plus Switzerland); the UK 10 Year Gilt is 0.8%, having been sub-0.2% four weeks ago, while the 2 Year Gilt is now on a positive yield again having been negative for several months.
The subtext remains the increased perception of inflation risk arising from a combination of factors most of which are interconnected: stimulatory fiscal and monetary measures to drive economic recovery post-Covid; the inflationary effect of the accelerated global climate change/decarbonisation programme; in the US, the political drive for social equality and opportunity potentially loading up business costs and raising expectations of potentially rising wages.
Almost exactly a year ago, in early March 2020, the major western central banks saw Covid still as some short-term event. The economy had caught a cold; a remedial interest rate cut, the economic equivalent of a couple of paracetamols and a day on the sofa in front of the telly, would suffice (the US Federal Reserve was not alone: the FT trumpeted from its front page the morning following the US central bank’s response; “The Fed rides to the rescue of the global economy”, little anticipating the near disaster just around the corner).
As investors fled to safety, what had been a mild dose of the economic flu rapidly took on the hallmarks of financial systemic sepsis, virulent and life-threatening. Significant, urgent intervention was required: cue zero interest rates (or even more negative ones in the eurozone) and gallons of intravenous antibiotic QE. Little has changed since in their approach; the US Federal Reserve, the European Central Bank, the Bank of England, despite their varying degrees of optimism for economic recovery, are all sticking very publicly to the same narrative: they are here to help, to be entirely supportive alongside their governments who are providing significant fiscal assistance; the outlook for intertest rates remains as they are now for the foreseeable future, the banks’ balance sheets are on standby to take a greater share of the load if needed. In the US, Jerome Powell was at it again this week in his testimony to Congress, cautiously optimistic for the economy, damping down fears of inflation, reassuring that the Fed will remain accommodative for the foreseeable future, there is no likelihood of the Fed tapering its relief.
Like Canute trying to hold back the waves, if Powell’s message was supposed to turn the tide of investor opinion, it failed. There is an old market adage, “don’t bet against the central banks” (more specifically, not against the Fed). But the markets are perfectly capable of making their own minds up about the perceived future risks and wanting to see that reflected in yield premiums. There is no sense of panic, as happens when a central bank decides it will withdraw liquidity from the markets, prompting what has become known as ‘taper tantrums’. Of interest though, is the extent to which such risk perceptions are spreading. Through the second half of last year western sovereign bond yields were diverging: in the US yields were rising, while in the UK and the eurozone they were falling, anticipating further remedial action from the Bank of England (not entirely misplaced given the Bank regularly flying its kite of the possibility of negative interest rates being deployed for the first time) and the ECB. In the past month, not only has that divergent behaviour ceased, but their bonds are also now travelling in step with those of the US. Even if they are not necessarily anticipating the level of inflation risk possible in the US, then at least sufficient economic recovery is in prospect that lower interest rates are no longer needed and the likelihood that the next change in rates (whenever that might be), will be upwards. What seems clear is that, even if investors are not actively betting against the central banks, trying to effect policy change, at the very least for the moment the central banks have lost the narrative. Nobody is listening, investors have moved on.
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.