Author: Dr Shane Oliver, Head of Investment Strategy and Chief Economist, published on 1 February 2018
For the first week of February 2018, Dr Shane Oliver, AMP Chief Economist, looks at the outlook for global inflation and bond yields.
The key points are as follows:
- Rising global growth and rising commodity prices indicate the risks to inflation are gradually moving to the upside. This is most acute in the US with the Fed likely to raise rates more than the market expects this year. The Fed’s January meeting indicated more confidence in the economic and inflation outlook consistent with a rate hike in March. We expect the Fed to hike rates four (or possibly five) times this year whereas the US money market is only assuming two or three hikes.
- This supports the view that the 35-year super cycle decline in bond yields is over.
- Higher US inflation and a more aggressive Fed will likely boost volatility this year. However, the back up in bond yields is likely to remain relatively gradual, and other countries including Australia will lag the US. (After the low December quarter inflation report we remain of the view that the RBA won’t start raising rates until late this year.)
Since the Global Financial Crisis (GFC) there have been a few occasions when many feared inflation was about to rebound and push bond yields sharply higher only to see growth relapse and deflationary concerns dominate. As a result, expectations for higher inflation globally has been progressively squeezed out to the point that few seem to be expecting it. However, the global risks to inflation and bond yields are finally shifting to the upside, with investment markets starting to take note as evident in the pullback in global share markets seen over the last few days. But how big is the risk? Are we on the brink of another bond crash that will engulf other assets?
Inflation and bond yields – some context
But first some context. In a big picture sense, inflation has been falling since the mid 1970s-early 1980sThe global economy is finally emerging from its post-Global Financial Crisis (GFC) hangover. Talk of secular stagnation was overdone. Slow global growth since the GFC largely reflected a typical constrained aftermath from a major financial crisis.
The fall in inflation over the last 30-40 years reflects: the inflation-fighting policies of central banks; supply side reforms that boosted productivity; globalisation that brought a billion or so workers into the capitalist system; and the benefits of the information technology revolution harnessed by the likes of Amazon and Uber. The fall in inflation in turn has been the main driver of a super cycle bull market in bonds, with yields trending down since the early 1980s. (Don’t forget, when bond yields fall, bond prices rise. Suppose the government issues a $100 bond paying $4 pa in interest for an initial yield of 4%. If investors push yields down to 3%, the bond’s price will be pushed up until the 3% yield is achieved with the $4 interest payment.)
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