The inflation bogeyman
Get ready for more bond-market scares
Anxieties about inflation, on which a constellation of asset prices depends, will persist
The week in financial markets got off to a breezy start, belying the turmoil of the previous week.
By the time the New York market closed on March 1st, the s&p 500 index of leading shares had risen by a carefree 2.5% on the day.
Europe’s stockmarkets had already followed Asia’s lead in closing sharply up.
The mood in Asia was helped by Australia’s central bank, which acted to calm bond-market nerves by announcing it would intervene to buy long-dated government paper.
Yields on ten-year Aussie bonds, which had risen quickly since New Year’s Day, fell by some 0.25 percentage points.
Stockmarkets gave up Monday’s gains on Tuesday and Wednesday.
But conditions in America’s government-bond market were somewhat calmer, in stark contrast to the week before, when anxiety about inflation took hold.
The steady fall in bond prices since the start of the year had suddenly quickened to a pace that threatened a destabilising rout.
During February 25th the benchmark ten-year Treasury yield spiked above 1.6% (bond yields move inversely to prices).
That is still low by historical standards, but a lot higher than it started the day, or indeed the year.
This prompted a big one-day fall in the s&p 500 and a bigger fall in the tech-heavy nasdaq.
Almost as suddenly, the worst fears about inflation have receded again—but perhaps not for long.
Much of what has happened is to be expected.
Bond prices ought to fall as the economy recovers.
The ten-year Treasury is the benchmark bond and is thus a barometer of risk appetite in markets and of economic confidence more broadly.
And it is global benchmark.
The sharp rise in Treasury yields from the start of the year until February 25th was matched by yields on bonds in other places (see chart 1).
Bond prices move in the opposite direction to confidence; bond yields go in the same direction as confidence.
When the outlook for the economy is bleak, as it was in March last year, yields fall sharply as investors rush to the safety of bonds.
As the outlook brightens, bond prices start to fall and yields start to rise again.
Bond prices are thus countercyclical most of the time.
This feature makes them very attractive diversifiers for equities, the prices of which are more procyclical, moving up and down in tandem with the economic cycle.
Mild inflation is not to be feared. Indeed it is in part changes in the market’s expectations of inflation that drive bond yields down in recessions and up in recoveries.
But hopes for a reflation of the economy can quickly spill over into fear of higher inflation.
The case for this seems stronger than it has for many years. The American economy is recovering quickly.
Fiscal transfers have left households with lots of extra savings.
Lockdowns have given rise to pent-up demand.
Already there is plenty of fuel for a spending spree when the economy reopens in earnest. And more is on the way.
President Biden’s $1.9trn stimulus package is likely to become law this month. A jump in the annual inflation rate seems assured in the coming months, if only because prices were depressed a year ago.
Perhaps, then, the strength of consumer spending, as people start to move around more freely, might further push it up.
These latent anxieties form the backdrop to the recent turmoil.
Three factors in particular seemed to be at work.
First, the market for future short-term rates started to price in interest-rate increases by the Federal Reserve by early 2023, sooner than the Fed had indicated thus far.
You can call this the inflation-fear element: if the economy seemingly has this much momentum behind it, can the Fed really hold off from raising rates for very long?
And if it tightens sooner, might the peak in interest rates be higher?
That would be a big concern for America’s stockmarkets, where high prices relative to future earnings are largely justified by the expectation that interest rates will remain very low for a long time.
Second, just as the market was having a rethink about Fed policy, the Treasury held auctions for two-year, five-year and seven-year bond issues on February 25th.
These are maturities that are sensitive to shifts in expectations about Fed policy in 2023-24.
Indeed the one-day rise in the five-year-bond yield was notable (see chart 2).
The auctions went poorly.
The seven-year bond had the lowest bid-to-cover ratio (a gauge of excess demand) for an issue of its kind for more than a decade.
This further spooked the market about the underlying demand for bonds.
Third, the volatility in the bond market seems to have caused liquidity to dry up. So for a given volume of selling, prices fell further than they otherwise might have.
Each of these three factors reinforced the other—hence the drama.
Given the anxieties about inflation, you may wonder why the bond market recovered its poise.
There are probably limits to how far an inflation scare can run this early in the economic recovery.
The message from the Fed’s rate-setters has generally been that they are not even thinking about thinking about raising rates or cutting back on bond purchases.
In a speech on March 2nd Lael Brainard, a Fed governor, stuck to that script.
“Today the economy remains far from our goals in terms of both employment and inflation, and it will take some time to achieve substantial further progress,” she said.
The intervention by the Reserve Bank of Australia is a reminder that central banks have the firepower to cap bond yields, if they are determined to do so.
And some private-sector investors will see value in Treasuries at these yields.
Foreign buyers from Europe and Japan, for instance, where yields are lower, may find them attractive.
All this has restored a measure of calm to the bond market. Ten-year Treasury yields are inching upwards again, having fallen back to 1.4%. The equity market is choppy, but that might be expected after such a long run-up in prices.
You could put the events of last week down to “technical issues”, the catch-all explanation for many a financial-market scare.
But that would be a little too sanguine.
Episodes in which trading liquidity suddenly dries up seem to be becoming more frequent in the Treasury market.
These sorts of scares will recur. Inflation is the bogeyman of financial markets.
A whole constellation of expensive assets depends on its quiescence.
No one can yet be confident that it will stay subdued.
Further bouts of bond-market jitters are likely before the year is out.
0 comments:
Publicar un comentario