Over recent weeks, there has been a sizeable selloff in bond markets, particularly US Treasuries, where prices have fallen sharply and yields have risen to around 1.6%. There is some nervousness that the cheap money being created by central banks, combined with Covid relief measures and recovering economies, may be the prelude to higher inflation, accompanied by rising interest rates. The 10 year US Treasury yield is now above that of the S&P 500, which is important because this, effectively, is the risk free return which other assets are benchmarked against and so the consequences are far reaching.
The Federal Reserve Chairman, Jerome Powell, recently played down inflation expectations, saying that it could take 3 years to reach the Fed’s target consistently. He went on to say that inflation was still ‘soft’ and that the central bank has the tools to fight it if it should run hot. However, there is evidence that inflation is already beginning to surface. Global food prices are rising sharply in some areas, as are commodities, from iron ore and copper, to oil, where prices have been steadily bouncing higher over recent months. In addition, Maersk, the large global shipping company, recently reported bottlenecks at ports as restocking by companies and consumers takes hold which, again, is leading to big price increases in some consumer goods. In the UK, Brexit is also having an impact on prices as new handling systems struggle to cope, leading to shortages of some goods. The UK’s Food and Drink Federation estimates that red tape and new border checks could add £3 billion in costs per year for food importers.
All of this matters because it can create uncertainty and volatility as investors rotate assets, both in terms of bonds/equities and sectors of the equity market, which may be helped or hampered by a rise in inflation and interest rates. No one is yet forecasting a huge paradigm shift, but in a market which is already having to deal with a number of other issues and uncertainties, it could create a measure of volatility in the short term as investors adapt.
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