The warning signs that the fight against inflation is far from won


The bond markets, for understandable reasons, attract less media attention than the stock markets.

A big fall in the stock market somehow feels more tangible, closer to home, to the man or woman on the Clapham omnibus – even though these days their pension savings are as likely to be invested in bonds as they are in shares . .

But then last year’s push in the gilt (UK government bond) markets after Kwasi Kwartengs mini-budget showed that what happens in the bond markets affects us all.

And right now some very interesting things are happening in the government bond markets.

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The interest rate (which rises as the price falls) on US government bonds on Tuesday hit its highest level since November 2007, when the global financial crisis was underway.

Bond yields are also rising in Europe.

In Germany, the yield on 10-year bunds – roughly the benchmark for the euro zone – hit a 12-year high on Monday, taking it back to levels last seen in July 2011 when the euro zone’s sovereign debt crisis was in full swing.

In the UK, meanwhile, gilt yields – while off their recent highs – stay close to the levels they hit in the wake of last September’s mini-budget.

So what happens?

Well, there are some factors specific to individual markets. For example, U.S. Treasuries are selling off in part because of concerns over the U.S. debt ceiling and the possibility, with Democrats and Republicans at odds over government spending levels, of a government shutdown that would see hundreds of thousands of federal workers laid off and government contractors. goes unpaid.

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But the most important factor at play is the dawning realization among investors that central bank interest rates may remain at elevated levels for some time.

That US Federal Reserve and Bank of England both hit the ‘pause’ button on further rate hikes last week, after a hike imposed by The European Central Bank a week earlier.

Still, the comments from the US and UK central banks – especially the Fed – strongly suggested that interest rates will remain at these multi-year highs for some time to come.

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This has also been the case in the eurozone. One of the reasons that interest rates are at a 16-year high is that some ECB policymakers have talked about the prospect of the bank’s key policy rate remaining at the current 4% for the foreseeable future.

As for the Bank of England, which may still have at least one more rate hike in its cupboard, no one in the markets seriously expects a rate cut until around this time next year at the earliest.

Information about all these interest rate expectations is the fact that oil prices have been trading at elevated levels.

A barrel of Brent oil last week hit $95.96 – a level not seen since last November – while the price during this quarter, the three months to the end of September, has risen by around 25% .

That makes this quarter the strongest for Brent Crude since the rally in the first three months of last year following Russia’s invasion of Ukraine.

This rise in oil prices has reminded investors that although the so-called ‘energy intensity’ of Western economies is lower than it was in the 1970s and 1980s, the battle against inflation is far from won.

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Inflation staying higher for longer means that interest rates will stay higher for longer, and right now central bankers don’t feel under pressure to cut interest rates.

Therefore, investors are adapting to this new world.

Nowhere can this be seen more clearly than in the tech sector.

A company’s stock price reflects what investors will be willing to pay for the company’s future cash flows, and since technology companies are considered to have better long-term growth prospects, they tend to be valued higher by the stock market.

When bond yields rise, the values ​​of expected future cash flows fall.

Investors find it harder to justify holding a highly valued technology stock in such circumstances when they could hold a less risky asset, such as a US Treasury bond, and pay them more in one go. The same phenomenon was seen early last year, then The Nasdaq briefly entered ‘correction’ territory.

Consequently, since their most recent highs in mid-July, shares of Microsoft are down 13%, Apple down 11% and the Nasdaq Composite down 8%.

There are at least a couple of ways to look at this selloff in Treasuries.

One is that this is a reversion to the mean. Jim Reid, head of global fundamental credit strategy at Deutsche Bank, reminded clients this morning that while 10-year US Treasury yields are around 4.5% for the first time since 2007, they are actually back to what they have been their average level for at least the last 230 years.

However, those of a less optimistic persuasion will look at the demographics.

In Western economies, baby boomers are now retiring in droves. It is now six years since Mike Wells, the former chief executive of insurance giant Prudential, told Sky News that over the next two decades, Americans would retire at a rate of 10,000 per year. day.

This will result in a supply shortage in both Europe and the US, not least in terms of the workforce. That will be good news for those in work and with skills that are in demand.

However, these supply shortages are also likely to cause inflation to erupt in all sorts of sectors. And that’s bad for bonds.


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