Is the bond rally “finally running out of road”? wonders Deutsche Bank. After a 35-year bull market, signs of a major turnaround are mounting. The yield on the UK ten-year gilt has jumped back above 1.1% as prices have fallen (they move inversely to yields). The yield hasn’t been this high since the vote for Brexit. The news that consumer price inflation (CPI) reached a two-year high of 1% year-on-year was behind the latest yield rise. Sterling’s sharp fall is stirring up future price rises by bolstering the cost of imported goods.
Simon Ward of Henderson Global Investors reckons inflation could be 3% by mid-2017. Annual growth in one measure of the money supply has jumped to 7.3% from 1.4% in 2011. “All significant upswings in inflation since World War II were preceded by a pick-up in money growth, typically by two to three years.” The ten-year gilt is hardly the only asset anticipating rising prices. The price of the 50-year index-linked gilt has climbed by 62% this year. Higher inflation reduces the real value of fixed coupons on bonds; the index-linked version protects investors from this risk.
This is not just a UK story. Benchmark bond yields in Germany, the US and Australia are also at four-month highs. The trend has spread to emerging markets, with Taiwan’s ten-year yield registering its biggest jump in three years this week. Yields on long bonds, especially vulnerable to inflation, have risen sharply. Evidence for a pick-up in inflation is certainly piling up. US CPI is back to a two-year high of 1.5%; the core rate (stripping out volatile food and energy prices) is close to a four-year high of 2.3%. Chinese CPI is at 2%, and producer price inflation’s first increase since 2012 suggests that some of the overcapacity in the Chinese economy has been mopped up.
It isn’t just Bank of England chief Mark Carney who has indicated he will tolerate a jump in inflation to ensure growth continues. Federal Reserve boss Janet Yellen has made clear she will let the US economy keep going and would prefer to be behind the curve on inflation. Central bankers have, after all, been trying to inflate our post-crisis debt load away for years; they won’t stop now they’ve created a little inflation.
“The Fed, in allowing inflation to run above target, may be changing the game,” Mizuho International’s Peter Chatwell told Bloomberg.com. “We finally have a fundamental reason for long-term yields to push higher.” With the tone of global markets usually set by America, the tide in bond markets finally appears to be turning. The bubble has met its pin.