Global bond markets have been generally weak so far this year but there is no single reason to accou...
Global bond markets have been generally weak so far this year but there is no single reason to account for it all. Each market seems to have its own anxieties.
In the US the worry is that the economy is growing too fast, while in Japan the fear is that the economy is growing too slowly. In Europe, disappointment about the euro (and some worries about imported inflation), together with the realisation that the European Central Bank will not cut rates much further, have encouraged yields upwards.
Finally, gilts have suffered from fears of a pick-up of the economy even though the MPC has been cutting rates most of the year and may need to go further. The G7 markets all continue to be nervous about the future but is the future so dire?
The answer depends on where you lie in the new paradigm debate. The US market in particular is most worried about too much good news - it does not seem right that GDP growth could be so high for so long while inflation and unemployment both manage to remain so low. Believers in the new paradigm argue this is because the US economy's potential (non-inflationary) growth rate is higher now than in the recent past, largely as a result of a technological revolution.
This idea is given short shrift by more conservative economists. If there is one key axiom to the new paradigm it is that the higher level of productivity growth observed in the US recently is not a flash in the pan but a new state of affairs. For example, in the 35 years between 1936 and 1970 (which included two wars), productivity growth in the US averaged just over 3%. What needs to be explained is why productivity growth dropped so far between then and now.
However, all this is moot when it comes to bonds. The market is scared of inflation, sees its spectre in every shadow and is taking no chances. US bonds will be attractive sometime later this year but not yet. Compared with the US it is easy to understand what is happening in Japan.
The economy is in the throes of an overdue restructuring which will involve significant further job cuts. Simultaneously, the government has staked its political future on producing economic growth of at least 0.5% this year.
The net result is that government revenues are collapsing, and expenditures are ballooning as stimulus packages are unveiled, each larger than the last. Not surprisingly bond yields are rising and will continue to do so.
European bonds are suffering, largely as a result of the weakness of the new currency but also in disappointment at the lack of forthcoming rate cuts from the ECB. We are left with the gilt market.
Rates have fallen but so far it has not been enough to bring the economy to a sustainable level of recovery. Although the Bank has eased again just recently, the MPC is in danger of undershooting its inflation target range - it may well have to cut further.
Chris Golden is economic adviser global fixed interest group at Fleming Investment Management
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