A Structurally Low-Yield Environment Isn’t Over Yet
By Michael Read, Bloomberg Markets Live Commentator and Reporter
The scale of this year’s move in rates markets goes some way to dent a core thesis on which many macro portfolios are based: that of a structurally low-yield environment. While global rates may well remain elevated, it’s debatable whether or not markets are facing a full-blown regime change. Given the market-implied path of policy tightening and the unprecedented selloff so far this year, it may not be time to completely retire your Never-Sell-Bunds T-shirts.
While the coronavirus pandemic and Russia’s attack on Ukraine have seen a broad-based and persistent snap higher in inflation, there are several factors at play that push against expectations for continued upward pressure on yields.
Commodities are in backwardation: the vast majority of the constituents of the Bloomberg Commodity Index show a strong backwardation out to 12 months from now. The bulk of the war-driven supply fears have caused near-term contracts to rocket higher, and while there are solid reasons for prices remaining above pre-Covid averages, there will be a degree of normalization ahead.
Inflation curves are inverted: whether that’s breakevens or zero-coupon inflation swaps, expectations are for lower inflation ahead. Naturally, lower inflation does not mean “low” inflation in pre-Covid terms by any means. But digging into the sub-components of the latest round of super-hot inflation prints gives some hope that we may be closer to cooler prices. Indeed, year-ahead inflation expectations have barely budged.
While longer-dated inflation tenors remain comfortably above longer term averages (despite the downward-sloping term structure), this more than likely reflects a variety of step-change inflationary impulses ranging from protectionism to greenflation discussed elsewhere.
Most developed-market meeting-dated OIS rates are pricing aggressively frontloaded, but ultimately rather short, hiking cycles to tackle their respective series of hot inflation prints.
This is because ultimately it all comes down to economic growth — something that can be viewed as a function of credit creation. As such, an uncomfortable observation is the turnaround in a measure of the euro-area credit impulse. No credit to tackle unexploited productive investment means stifled growth; less growth means fewer reasons for yields to continue to march higher.
Nowhere is this clearer than in Europe, whose disparate economies are relatively more exposed to the fallout of war. During the Fourth Phase of ECB monetary policy (blue box), namely ultra-low inflation and QE, we have become accustomed to radical actions with little inflationary impulse. Even as we emerge from that dynamic, much of the recoupling of inflation with yields should come from the inflation side in the months and quarters ahead.
Indeed, we have already seen policy trial balloons suggesting the ECB is working on a crisis tool to deploy in the event of a blowout in the bond yields of weaker euro-zone economies in the event of shocks outside of the control of their respective governments.
It’s clearly a long long way from the central bank put of a “Super Mario”-esque intervention that the market has become accustomed to. While the European bond space may remain in a sell-rallies-mode for some time to come as inflation cools, the dilution or outright absence of a calming central bank influence will not stop fixed income’s recent one-way street from moderating as we progress into 2Q
Tue, 04/19/2022 – 20:45