Global Bonds: Risking a Rude Central-Bank Awakening

Central banks are growing more confident on the outlook. Bond markets look too relaxed.

By Richard Barley

     U.S. Federal Reserve Chairman Janet Yellen pictured on a TV screen at the New York Stock Exchange last December. Photo: lucas jackson/Reuters


Time to look in the mirror? Markets spend a lot of time thinking about how central banks will react to the economic environment. Perhaps investors should be reflecting more about how they are reacting to central banks.

In the past week or so, a distinct shift has emerged from leading central banks around the world. The U.S. Federal Reserve lifted rates a quarter point and signaled it would keep on going. The European Central Bank injected a note of hawkishness into its otherwise dovish stance, with growth and inflation picking up. Even the Bank of England managed to find a policy maker willing to vote for a rate increase and gave the minutes of its March meeting a less-dovish spin. The Bank of Japan, sticking to plowing a furrow of permanently loose policy, looks like the odd one out.

Investors in risk assets, such as stocks and emerging markets, liked what they heard about growth from central bankers. Bond market investors have also seemed to hear a reassuring message.

U.S. government bonds posted their largest one-day gain in nine months as the Fed raised rates.

In Europe, 10-year German bond yields are still stuck under 0.5%. The repricing of government bonds that occurred last year after President Donald Trump’s election victory hasn’t really progressed further. Long-dated yields have broadly been going sideways for more than three months.

The U.S. March rate increase had to be telegraphed loud and clear to investors. Markets only realized that the move was coming after a campaign of communications from policy makers that couldn’t be ignored. Then, investors appear to take Fed Chairwoman Janet Yellen’s comments after the increase as a sign they could relax again.

Perhaps as a result of the long period in which central banks seemed to be the only game in town, markets seem to be willing to be spoon-fed by policy makers instead of actively anticipating these changes, which raises risks around any shift in communications. That was clear in the U.K. as gilt yields jumped after the BOE minutes were published Thursday, even though the BOE might be the one central bank less likely to follow through given the uncertainties of the Brexit process in the coming months.

Of course, there are still reasons to worry about the outlook. The list of concerns includes fears about protectionism stifling trade, political disruption in Europe, and lingering doubt about China’s ability to sustain strong growth.

Questions remain about whether the rise in inflation is transitory and might fade as last year’s moves in oil prices drop out of the picture, or whether price pressures are picking up more broadly. Central bankers will have to reflect that in their communications, and policy does appear likely to move slowly.

Still, investors in bond markets may be generating risks for themselves if they are cherry-picking what they want to hear from central banks. If growth holds up, and underlying inflationary pressures continue to build, the tone from central banks should harden. Investors shouldn’t feel too relaxed about that prospect.

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