Bond yields and a new season’s flowers both sprung up last month, heralding an end to the dark days of lockdown winter. Chief investment officer Julian Chillingworth ponders the big question on investors’ minds – does this also foreshadow a prolonged period of higher inflation?
Bond markets have been the centre of attention as benchmark government yields jerked higher from late February. The 10-year US Treasury yield broke through 1.55% which is the highest level since the pandemic hit the West last February. For most of 2020 the yield traded between 0.60% and 0.80%. While the actual change may seem small, it’s the relative that matters: the borrowing cost has roughly doubled in a short space of time.
There are many factors influencing bond yields at the moment. Primarily, expectations are growing that an explosive reopening, when it arrives, will send inflation much higher. Yields also seem to be correlated with vaccination programmes: as inoculation spreads, hopes for successful reopenings rise. That leads investors to sell ‘safe-haven’ government bonds so they can buy riskier assets, like stocks and higher-yielding corporate bonds, to profit from any economic recovery and the accompanying bounce in companies which can start operating normally again. The selling pressure pushes government bond prices lower – and therefore the yields higher. Meanwhile, the prices of those stocks and bonds whose fortunes are entwined with reopening are pushed higher by the weight of buyers.
Any further increases in government bond yields will keep stock markets on their toes. Also, it will be important to listen closely to the US Federal Reserve (Fed). America’s central bank is ensuring that short-term government yields stay extremely low by purchasing large amounts of those bonds. But they are not yet applying the same weight of purchases on longer-term debt (including the 10-year). Bond investors want to see them in control of the longer-term debt markets, especially as the huge sums the US government has spent on pandemic support has dramatically increased longer-term borrowing. With a new $1.9 trillion support package having been agreed by both chambers of Congress, even more debt is coming down the pipe. The Fed may be forced into action.
A simpler life?
Flowery flashes of colour are popping up in the fields and impatient spring is in the air. Yet it will take much longer for our own re-emergence from the pandemic winter as the UK government plans an extremely cautious trek back to normalcy. It won’t be till after Easter that many shuttered businesses will be able to reopen.
The question on everybody’s mind is, what will people do when lockdowns are eased? Virtually everyone will want to rush out and throw their money around like confetti, enjoying all the things that we’ve missed out on during a year of house arrest. Yet it takes more than desire to make a transaction.
First off, many have had a really tough time during the pandemic. Hundreds of thousands of people have lost their job in the UK alone. Globally, the job losses run into the tens of millions. A whole host of people will be worried about how secure their livelihood is. Even among the more fortunate, whose employment has been unaffected and their industry perhaps boosted by the pandemic, has a year of making the most of home comforts meant that, longer term – after the initial excitement of release – they may have picked up habits that make them less inclined to spend so much time out and about. Maybe they’ve found that, after all, some of the best things in life are free?
Secondly, a whole lot of businesses will have folded during arguably the most difficult year ever for the entertainment, travel and services sectors. Airlines have needed bailing out, pubs have shuttered, theatres have stood empty. When economies open up, it seems reasonable to expect that demand will dramatically outstrip supply, driving up the cost of social activities as the survivors are inundated with bookings.
Perhaps people will content themselves with sharing a bottle of wine with friends in a local park, rather than paying a hefty bill for the same thing in a packed bar with no seats. If more people take the cheaper option, that will have a significant impact on what economists call the ‘aggregate demand’ of our nation, the total amount of economic activity we generate. And when that demand changes, it has implications for unemployment.
This is the really interesting dynamic here. How much has the pandemic changed people’s behaviour? And how will we react to changes in the market for the things we used to take for granted? Only time will tell.