As calls to dump government bonds heighten, Chris Wyllie, chief investment officer at Iveagh, warns investors not to be too hasty.
Rarely in financial times has one man saying so little had such a big impact on asset prices. If what Ben Bernanke said on 22 May – that the Fed would start reducing quantitative easing (QE) if the US economy continued to strengthen – was a bombshell, it must surely have been a neutron bomb. No blinding light but devastating nevertheless.
The market has become used to clear guidance from the Fed. Ben Bernanke has said he sees this sort of guidance as an instrument of policy in itself – in effect, ‘verbal QE’.
But the market may have misunderstood Bernanke’s intentions. He was not, in fact, dropping a hint about when QE was likely to end; indeed, his comments were sufficiently caveated for this not to be the case. Rather, by withdrawing clear guidance, he was in fact implementing the first phase of policy tightening. It has worked like a dream.
You might be glad of that govt bond exposure after all
Bernanke has effectively told markets they are going to have to start figuring out the right price for bonds themselves once more rather than simply relying on the ‘Bernanke put’. The effect has been a bit like taking the stabilisers off a child’s bike. After the initial shock of being told to fend for themselves, markets are slowly getting to grips with it.
The initial response has been to push 10-year US treasuries back up to 2.5%: the highest level since the introduction of QE2 and QE3. Of course, it is still low compared to history but, by the same yardstick, so is inflation, with the latest US CPI number coming in at 1.4% year-on-year.
You may take the view that this is only temporary but with commodity prices still under pressure, it is difficult to spot where the inflationary impulse is coming from in the near term.
That means government bonds are offering a 1% real yield compared to spot inflation and 0.5% compared to the Fed’s longer-term inflation goal. That is also low by reference to history but is a lot better than the negative real yields we have seen more recently and which still exist on cash.
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