Bond traders revolt
gLOBAL OBLIGATION the markets are waking up from a long sleep. The Federal Reserve announced this week that it would end its massive bond buying program. At the same time, bond investors are responding to higher inflation: In a group of 35 economies, five-year bond yields have increased on average 0.65 percentage points over the past three months. An upheaval is taking place not only in emerging markets, but also in rich countries like Australia and Great Britain. Sudden moves inevitably raise fears of market turmoil, such as the taper tantrum of 2013. However, the bond shift taking place today is actually quite different.
Before the pandemic, interest rates around the world were low, reflecting latent inflation. When the coronavirus hit nearly two years ago, most central banks pledged to keep their policy rates lower for longer to help the recovery. Many also agreed to buy bonds, reducing their yields.
The main reason for this sudden change today is rising inflation. Among the 38 member economies of the OECD, a club of rich countries, inflation hit an uncomfortable 4.6% year on year in September. Soaring energy and food prices are only part of the story: even if you take them out, the figure was 3.2%, the highest in nearly two decades.
For months, central banks have been saying high inflation is a blow caused by temporary supply constraints. But action in bond markets shows investors believe central banks are acting too slowly. Some monetary authorities have already tightened their policies. Brazil announced a rate hike of 1.5 percentage points last week. The central banks of Canada and Australia have abandoned forecasts that rates will remain low. As of this writing, the Bank of England must decide to raise rates. Some policymakers are holding on: Christine Lagarde, the boss of the European Central Bank, insisted that it is “very unlikely” to raise interest rates next year.
The specter of central bank deviations from markets, and the resulting fluctuations in interest rates, will confuse those who remember 2013, when the Fed awkwardly revealed its unexpected intention to start scaling back its program. bond purchases. The resulting mini-global panic shook growth and knocked out some emerging economies, especially those with large dollar debts.
However, we are not in 2013. One difference is that the evolution of the bond markets is more nuanced. The rise so far in nominal five-year government bond yields in America, for example, is less than half of what it was eight years ago. Real bond yields, after factoring in expected inflation, are minus 1%, still close to record lows. This will promote easy conditions in the real economy. And while yields on short-term government bonds rise, there has been much less movement in long-term bonds.
The other difference today is the absence of financial panic. An increase in the cost of debt can lead to defaults and capital flight. But many emerging economies have healthy foreign exchange reserves, which makes them resilient. Stock markets show no signs of distress: Stock prices hit an all-time high this week. Bank stocks have risen 28% this year, as rising interest rates can increase their profits. And the bond markets remain open for business. In October, emerging markets outside of China issued near-record levels of corporate and sovereign debt.
No reason to be alarmed, then. Markets are betting that central banks must accelerate interest rate hikes, not that they will lose control over inflation. Nevertheless, it is worth bearing in mind the extraordinarily difficult task facing central banks. During the unpredictable end of a pandemic, they must try to normalize ultra-accommodative monetary policy amid extremely high asset prices, high debt levels and above target inflation. Typing tantrum 2.0 is not yet in progress. But don’t rule out a bigger bond brawl. ■
This article appeared in the Leaders section of the print edition under the headline “Bond traders are agitated”