Your weekly economic update from the team at FXD Capital
Inflation expectations dominated the week’s news, in which longer-dated bonds continued a steady sell-off. Effects rippled into stock markets, with growth technology stocks and commodities/financials faring the worst and best, respectively.
With all this going on, how are rising yields impacting the short-term money markets? At first glance, it appears to be very much business as usual. 3 Month GBP LIBOR rose about 3bps on the week, and the Royal London Short Term Money Market fund has been mostly flat at the month, only dropping this week by 1bp.
Major sovereign yield curves have been twisting in recent months, typically with the 5-year mark representing the inflexion point. For example, the UK yield curve has seen the 1-year rate fall 53 bps over the past year, while the 50-year bond rose 39bps.
Across all sovereign bond markets, there were steep sell-offs. Just over the past month, we have seen the following changes in 10-year government bond yields: Australia +52bps, Germany +25bps, Japan +9bps and US +35bps. Australian and New Zealand government bonds caught a lot of the week’s crossfire due to higher inflationary pressures, from their economies having fared relatively well during the pandemic and both experiencing housing booms.
For savers, a likely traverse of short-term interest falls may be necessary on the path to higher savings rates. The effects of longer-dated bonds and stocks selling off is that money is out of the market, sitting in short term cash accounts. When the dust settles, money may eventually go back into the longer-term bonds if yields stay high. A scenario where short-term rates rise would be if there are firmer signals about rate rises or a liquidity shock, but the signs from central banks are that those conditions will not be permitted.
News during the week suggested a schism existing in the BOE about to boost economic recovery from the ongoing pandemic. The split is between those favouring expanding the quantitative easing programme and others who prefer the great unknown of negative interest rates. The calls for negative rates resonate as it’s an option that may stimulate more incentive to borrow and spend in the real economy, which quantitative easing has offered mixed results in.
The latest unemployment figures show an uptick in the health of the economy. While the jobless rate hit 5.1% in Q4 2020, the numbers on payrolls are rising again, with the labour market shows signs of stabilising. When the cloud of the furlough scheme clears, we may see the jobless rate rises to 6.5% by the end of the year as the aftermath materialises.
Jerome Powell gave a two-day testimony to the Senate Banking Committee, all taking place during the week’s bond sell-off. The headline outcomes signalled a slight dampening of his enthusiasm towards President Biden’s $1.9 trillion spending plan. While once seen a supporter of the measures, he passed on the opportunity to provide outright partisanship to the bill when pressed by lawmakers.
Under questions about Fed policy – intriguing in the market sell-off context – Powell remained firm in its current stance of not raising rates until full employment and 2% inflation was achieved. In his “hope for a return to more normal conditions”, the indicators are that the Fed will continue to maintain its economic support.
With some commentators stating that the bond sell-off is being enacted by “bond vigilantes” looking to use activism to instigate central bank change, it will be interesting to see which side twitches first.
On Thursday, Philip Lane, Chief Economist to the ECB, commented that the bank would increase the pace of emergency bond purchases to “preserve favourable financing conditions” to counteract yield rises in sovereign debt markets. With just under €1 trillion of its pandemic emergency purchase programme dry powder remaining for the next year, the ECB should be suitably well-equipped. Lane defined favourable financing conditions as reflecting activities in the band lending and market-based funding (e.g. repo) markets.
Bund spreads to US Treasurys have continued to widen (currently -171 bps), with the latter having sold off more in the week’s events. At the height of risk aversion in Spring 2020, the spread sat at -106 bps, since then has grown as the US economy began to open up at a faster pace.
All the best for the week ahead,
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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