Bond markets give central bankers a telling off
Posted 29 October 2021
Capital markets enjoyed another good week, although with one notable difference – this time bond investors were allowed to join in. Just as energy prices started stabilising, corporate earnings results proved less supportive than in the previous week, while macroeconomic data continued documenting the anticipated slowdown of the global economy. This resulted in a slight deterioration of investors’ growth expectations for next year, which was not enough to rob equity markets of medium-term support but sufficient to move bond markets. As we have written here so often recently, bond markets are currently quite influential.
With current inflation pressures proving more stubborn than the central banks’ transitory description has us think, short-term yields rose, whereas longer maturity yields (more susceptible to weaker growth expectations) fell quite noticeably. Gone are the heady days of the first half of the year, when talk of the onset of a ‘roaring twenties’ decade saw growth expectations go overboard and longer maturity yields rise so uncomfortably fast that equity investors started to fear their competition. This week, it was the other way around; falling bond yields gave equity holders comfort that even more benign corporate profit growth rates might still shine relative to what is available in bond yields.
While central banks like the European Central Bank (ECB) continued to repeat their mantra of lower rates for longer, bond markets told them in no uncertain terms to wake up and smell the coffee – and of inflation eating away even more at their meagre-to-negative yields. Only the central bank of Brazil has bowed to the pressure so far, but with a 1.5% rate hike, they certainly set the mark of what is possible.
We should always refrain from reading too much into one week of capital market movements, but the UK’s Budget announcements were a case in point. No matter how much Chancellor Rishi Sunak tried to portray his Budget as one of fiscal expansion to get the economy back onto a better growth trajectory, commentators and markets looked through the short-term fiscal easing and focused on the medium-term tightening through rising taxes. The unwinding of pandemic support programmes constitutes a formidable challenge to governments around the world, because unless the private sector picks up the slack at the same rate as governments remove the support, it becomes a drag on the combined demand than drives the economy.
The biggest fiscal support expectations were always centred on the US, and here at least there appeared to be some light at the end of the tunnel as political negotiations progressed. But however you look at the picture as a whole, with the monetary tightening that is taking place – courtesy of the bond markets pre-empting what central banks are loath to do – the fiscal easing that would counterbalance this (and also put global economic growth onto a more even keel) is not as forthcoming as expected and telegraphed earlier in the year.
Those who were expecting investment programmes to counter climate change to tip the fiscal spending balance for the economy are eagerly looking to the COP26 gathering of world leaders in Glasgow over the coming fortnight. We are not holding our breath for any big breakthroughs and announcements, but would very much like to see the current talk around creating more reliable investment frameworks converted into meaningful action and progress. It is all very well to call for the ‘invisible hand’ of markets to help fix the problem, but unless leadership is forthcoming in creating a reliable globally-binding framework in which investors gain more planning security, then announcements by big investment groups may prove just as toothless now as political leaders aspirational CO2 reduction announcements did at past COP meetings.
None of this week’s events and insights are in any way earth-shattering or deeply worrying for investors. They simply suggest that the economic upside (and therefore the investment upside) was this week seen as more limited than previously anticipated. There are plenty of voices reminding us this is all still part of the ‘climbing the wall of worries’ narrative discussed here before. We would largely agree, but as with the threat of climate change counter action, time is of the essence if we want to experience a brighter future than the ten years behind us.