The inflation question and higher bond yields
Chief Economist & Fund Manager
A short while ago I questioned if 2021 might be a sell the COVID 19 vaccine news trade. I said it probably won’t, because central banks will keep pumping liquidity. However, a new twist is now unfolding, and that is higher bond yields.
For example, 10-year US government bonds yields have risen to 1.5%, and the 30-year yield is now at around 2.20%, with most yields in other major markets also increasing.
In my mind, irrespective if inflation comes back, as most think it will, I find it hard to believe that the long end of sovereign debt can increase by a lot without central banks intervening. This because the interest cost to governments will rise substantially, something that will make an already bad fiscal situation much worse.
So, the question is, can central banks bring down long dated bonds if they want to? The answer is yes, and I think they will do just that at some point. But the even more important question is, how might markets react to such a development? The answer is we don’t really know, because on the one hand we will have inflation and higher growth because of a COVID vaccine, but yields will not be reflecting such a reality, as they have in the past.
My guess is that if markets start correcting, central banks will communicate that they will start buying longer dated bonds to keep yields down to avoid markets correcting by much. But the truth is we don’t know how markets will react to such a reality, irrespective of what central banks say and do. But until we see price action to the contrary, we have to keep trusting an old Wall Street saying that says never fight the Fed, or generally speaking, never fight Central Banks.
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