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The recent rise in bond yields and US inflation expectations have warned investors that a repeat of the ‘taper tantrum’ in 2013 could be on the horizon.
The US Treasury note for ten years climbed above 1.3% for the first time since February 2020 earlier this week, while the 30-year bond also reached its highest level for a year. Yields move inversely to bond prices.
Yields tend to close with inflation expectations, which have reached their highest levels in a decade in the US, driven by increased prospects for a large fiscal stimulus package, advances in vaccine rollouts and pent-up consumer demand.
The ‘taper tantrum’ in 2013 was a sudden rise in treasury yields due to market panic after the Federal Reserve announced it would begin declining its quantitative easing program.
Large central banks around the world have lowered interest rates to historic lows and launched unprecedented amounts of asset purchases to boost the economy throughout the pandemic. The Fed and others have maintained supportive tone in recent policy meetings and promised to keep financial conditions afloat as the world economy appears to be out of the Covid-19 pandemic.
However, the recent rise in yields suggests that some investors will expect a policy tightening sooner than expected to accommodate a potential rise in inflation.
If central bank support is removed, bonds usually fall in price yielding higher returns. It can also spill over into stock markets, as higher interest rates mean more debt service for businesses, causing traders to reevaluate the investment environment.
“The supportive stance of policymakers is likely to remain in place until the vaccines pave the way for some return to normalcy,” Beaufort Investment chief investment officer Shane Balkham said in a research note this week.
“However, there will be a risk of another ‘taper tantrum’ similar to the one we saw in 2013, and that is our main focus for 2021,” Balkham predicted, should policymakers begin to unwind this stimulus.
Long-term returns in Japan and Europe followed the US Treasury higher towards the end of the week as the portfolio effects shifted.
“The fear is that these assets will be priced to perfection when the ECB and Fed can finally decline,” Sebastien Galy, senior macro strategist at Nordea Asset Management, said in a research note entitled “Little taper tantrum”.
“The chances of it shrinking are helped in the United States by better retail sales after four months of disappointment and the expectation of a major issuance of the $ 1.9 billion fiscal package.”
Galy suggested that the Fed is likely to extend the duration of its asset purchases, which will reduce the upward momentum in inflation.
“Stock markets have reacted negatively to higher returns because it offers an alternative to the dividend yield and a higher discount on long-term cash flow, making them more focused on medium-term growth such as cyclicals,” he said. Cyclicals are stocks whose performance tends to adapt to economic cycles.
Galy expects this process to be stronger in the second half of the year as economic growth increases, increasing the potential for downsizing.
Taps in the US, but not Europe
Allianz CEO Oliver Bäte told CNBC on Friday that there was a geographical difference in the German insurer’s thinking about the prospect of interest rate hikes.
“The one is Europe, where we still have financial oppression, where the ECB is still buying the maximum to limit spreads between the north and the south – the strong balance sheets and the weak – and at some point someone I will have to price paid for it, but in the short term I do not see any interest rate increases, ‘said Bäte, adding that the situation is different.
“Because of the massive programs that have taken place, the stimulus that is taking place, the dollar as the world’s reserve currency, there’s a clear trend to fuel inflation and it’s going to come. Again, I do not know when and how, but the interest rates has increased and it should continue to rise. ‘
Rise produces a ‘normal feature’
However, not all analysts are convinced that the increase in bond yields is material for markets. In a note Friday, Barclays, head of European equities strategy, Emmanuel Cau suggested that rising yields were in arrears because they had left the improved macroeconomic outlook for the second half of 2021, saying it was a “” normal feature “of economic recovery was.
“While the main drivers of inflation are emerging, the prospect of even more fiscal stimulus in the US and the pent-up demand driven by high excessive savings, it seems right that yields are catching up with other more advanced trade in inflation, “Cau said. and added that central banks remain ‘firmly on guard’, given the balance between risks.
He argued that the rising yield curve is ‘typical in the early stages of the cycle’, and that, as long as vaccine roll-out is successful, growth continues to pick up and central banks remain cautious; stocks should be able to withstand higher rates.
“Obviously, stocks have been taking a break after the strong move of the past few weeks, as many sectors that have been rising with returns look excessively like commodities and banks,” Cau said.
“But at this stage, we believe that rising returns are more a confirmation of the stock market than a threat, and therefore declines need to be bought.”