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The recent rise in US bond yields and inflation expectations has some investors worried that a repeat of the 2013 “cholera crisis” may be on the horizon.
The 10-year U.S. Treasury benchmark rose above 1.3% for the first time since February 2020 earlier this week, while the 30-year bond also reached its highest level in a year. Yields move inversely to bond prices.
Yields tend to increase in line with inflation expectations, which have reached their highest levels in a decade in the United States, driven by growing prospects for a large fiscal stimulus package, progress in vaccine launches and pent-up consumer demand.
The “taper tantrum” in 2013 was a sudden increase in Treasury yields due to market panic after the Federal Reserve announced it would begin to reduce its quantitative easing program.
Major central banks worldwide have cut interest rates to historic lows and launched unprecedented amounts of asset purchases in an attempt to support the economy during the pandemic. The Fed and others have maintained a supportive tone at recent policy meetings, promising to keep financial conditions relaxed while the global economy appears to emerge from the Covid-19 pandemic.
However, the recent rise in yields suggests that some investors are beginning to anticipate a policy tightening earlier than anticipated to accommodate a potential increase in inflation.
With the removal of central bank support, bonds generally fall in price, which increases yields. This can also affect stock markets, as higher interest rates mean more debt service for companies, causing traders to reevaluate the investment environment.
“Legislators’ supportive stance is likely to remain in effect until vaccines have paved the way for some return to normal,” Shane Balkham, chief investment officer at Beaufort Investment, said in a research note this week.
“However, there will be a risk of another ‘cholera attack’ similar to what we witnessed in 2013, and this is our main focus for 2021,” projected Balkham, should policymakers start to lessen that stimulus.
Long-term bond yields in Japan and Europe followed the US Treasury’s highs at the end of the week, with bondholders changing their portfolios.
“The fear is that these assets will be priced perfectly when the ECB and the Fed may eventually decline,” said Sebastien Galy, senior macro strategist at Nordea Asset Management, in a research note entitled “Little taper tantrum”.
“The chances of reduction are helped in the United States by better retail sales after four months of disappointment and the expectation of large issues from the $ 1.9 trillion tax package.”
Galy suggested that the Fed would likely extend the duration of its asset purchases, moderating the spike in rising inflation.
“The stock markets reacted negatively to higher yields, as they offer an alternative to dividend yield and a greater discount on long-term cash flows, making them more focused on medium-term growth, such as cyclical ones “, he said. Cyclicals are actions whose performance tends to align with economic cycles.
Galy expects this process to be more pronounced in the second half of the year, when economic growth intensifies, increasing the potential for gradual reduction.
Decreasing in the US, but not in Europe
Allianz CEO Oliver Bäte told CNBC on Friday that there was a geographic divergence in how the German insurer is thinking about the prospect of interest rate hikes.
“One is Europe, where we continue to experience financial repression, where the ECB continues to buy as much as possible to minimize spreads between north and south – strong and weak balance sheets – and sometime somebody is going to have to pay the price for that, but in the short term I don’t see any increase in interest rates, “said Bäte, adding that the situation is different in the United States.
“Because of the massive programs that have taken place, the stimulus that is taking place, the dollar being the world’s reserve currency, there is clearly a tendency to fuel inflation and it will happen. Again, I don’t know when and how, but interest rates have fallen and must be falling even more. “
Raising produces a ‘normal feature’
However, not all analysts are convinced that the increase in bond yields is significant for the markets. In a note on Friday, Barclays’ head of European equity strategy, Emmanuel Cau, suggested that the increase in bond yields was delayed as they were lagging behind the macroeconomic outlook for the second half of 2021, and said they were a “normal feature” of the economic recovery.
“With the main drivers of inflation pointing upwards, the prospect of even more fiscal stimulus in the U.S. and pent-up demand driven by high savings surplus, it seems certain that bond yields will reach other more advanced reflecting businesses,” said Cau, adding that central banks remain “firmly on hold” due to the balance of risks.
He argued that the slope yield curve is “typical in the early stages of the cycle” and that as long as vaccine launches are successful, growth will continue to rise and central banks will remain cautious, inflationary movements between asset classes appear “justified” and stocks must be able to bear higher rates.
“It is clear that, after the strong movement of the last few weeks, the shares may mark a pause, since many sectors that have recovered with yields seem overbought, like commodities and banks,” said Cau.
“But at this stage, we believe that rising yields are more a confirmation of the bullish stock market than a threat, so the falls should continue to be bought.”