The Economist March 6th 2021 pp66-68 |Finance & economics|Financial Markets| “The inflation bogeyman” “Get ready for more bond-market scares”
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Note part of The Economist article but a helpful perspective on current thinking
Read the article for full detail
Data presented in charts
Increase in ten-year government bond yields in local currency Jan 4th-Feb 25th 2021 in percentage points (Approximate)
Brazil +1.6%
Canada +0.8%
Mexico +0.8%
Russia +0.8%
Britain +0.6%
United States +0.6%
Germany +0.4%
India +0.4%
South Africa +0.4%
Italy +0.3%
Japan +<0.2%
(2244 Editorial note. Governments sell bonds to fund government debt. During an economic recovery the price investors are willing to pay falls. The idea being that better economic returns will be had by investing in the stock markets rather than fixed income government bonds. Governments needing to sell these bonds respond by issuing bonds that pay a higher rate/yield. Businesses/Stock markets worry that a rapid rise in demand for goods and services, in an economic recovery, will outstrip supply leading to increased prices along the supply chain. Companies then raise prices on finished goods, as an economic necessity, thereby reducing consumer’s buying power leading to lower demand. Lower demand decreases corporate revenue and profit. Rising bond yields impact businesses directly as well because corporate lending rates, and corporate bonds that are issued as well, are indexed, at least partly, against the Fed Rate. Paying more to service corporate debt narrows profitability. For these reasons, businesses and the stock market want to avoid higher prices and interest rates.)
United States, Treasury Yields (%)
Ten Year/(Five Year)
Jan 2020 ~1.7% (1.6%)
April 2020 ~0.6% (0.2%)
March 2021 ~1.5% (0.7%)
Summary of Article
Currently bond prices and yields are reflecting what is expected in an economic recovery-bond prices are falling so central banks issue new bonds at higher rates to ensure selling enough to fund government debt. Businesses and the equity markets worry about rising interest rates and rising prices for supplies and finished goods. These worries, along with hype by pundits and the media, stoke the fear of inflation. Behind the scenes we know that “Lockdowns [caused by the pandemic in this case] have given rise to pent-up demand. Already there is plenty of fuel for a spending spree when the economy reopens in earnest.”…”A jump on 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.”
A few factors are at work.
1) “The market for future short-term rates started to price in interest rates by the Federal Reserve by early 2023, sooner than the fed had indicated thus far”. If the Fed can’t hold off rates then a business’ future earnings could fall because they hadn’t anticipated higher borrowing costs.
2) On February 25th “the Treasury held auctions for”…two, five and seven year bonds. These shorter-term bonds best reflect recent shifts in perceived future rates. These auctions were heavily sold reflecting high demand-an institutional belief that there will be increased inflation.
3) Because the bond markets have fluctuated widely during this time “for a given volume of [bond] selling , prices fell further than they may have otherwise.” (See above rates for five year bonds more than tripled from 0.2% in April 2020 to 0.7% in March 2021).
The question now is will rising rates continue? The Fed opined.
“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…”. Reportedly, “the Fed’s rate-setters…are not even thinking of…raising rates or cutting back on bond purchases.”
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