If one thing characterises the morbid groupthink of recent times, it is the inexplicable demand for bonds and bond-like assets despite their truly pitiful returns. At the same time, historically low bond yields have fed the gloom of investors: “Larry Summers can’t be serious that growth is over, can he?”, “Well, perhaps, just look at those yields!”
No more. Bond yields are on the rise. The US 10-year government yield has risen from less than 1.4% in July to 2.5% today, accounted for by all components: rising growth expectations, rising inflation expectations and a rising term premium. The Fed tightening cycle is back in play. Pre-election, futures were pricing in a Fed funds rate of less than one at the end of next year; now they’re pricing about 1.75. And whatever Mr Draghi says, the ECB just tapered QE.
One of the most fascinating macro debates of the past year has concerned the ‘Neo-Fisherian’ claim that we ought to re-write the economic textbooks because interest rates don’t have a negative effect on growth and inflation, they have a positive effect. We’re not ripping up our textbooks, but do believe that amid rudderless soul searching during the post-crisis era, investors and even policy makers have peered deep into the distorted mirror of the markets for the answers. That was foolish and surprise, surprise, now that yields are rising, there is an almost audible collective sigh of relief. When yields rose quickly during the Taper tantrum of 2013 the VIX index shot up, indicating distressed inventors. But as yields have risen rapidly since the US election, the VIX is down.
The real world fundamentals are supportive of higher yields and a stronger US dollar and were so before Trump. Just look how far they have steadily come since this time last year. US underlying inflation has risen from 1.3% to 1.7%* and global PMIs have been strong since spring. On a real-time basis, global GDP growth is likely running well above 4% annualised right now, compared to about 2% in March.
