Equity risk of bond yield climb
If ten-year bond yields rose by 50 basis points to 3%, there could be an impact on equities, warns Dhaval Joshi of BCA Research. At that level, the risk return of bonds begins to match stocks.
But Joshi does not see bond yields going much past 3%. He sees markets being at the tail end of a rising bond yields mini cycle, which is unlikely to last far beyond the first quarter (Q1).
China Treasury sales?
In response to the concerns that China would become a seller of US Treasuries, Joshi said this would have a currency impact, rather than an impact on bond yields.
The Federal Reserve (Fed) has already begun quantitative tightening, selling bonds to reduce its $4.5 trillion balance sheet, initially at a slow $10 billion a month. It has also started tightening interest rates and two or three more quarter-point rises are expected this year.
ECB and BoJ behind the curve
Deposit rates in the eurozone are at 0.4%, while Japan’s are at 0.1%.
The European Central Bank (ECB) and Bank of Japan (BoJ) are behind the curve in that the emergency policy is inappropriate for the current state of their economies, says Joshi. Inflation in the euro area is not that different from the US and growth is better, and in Japan inflation has picked up to 1%. He adds that Fed policy is appropriate.
He sees no need for the ECB or BoJ to rush into rate rises but rather to raise expectations that increases are on the way.
Earlier this week the BoJ purchased fewer bonds in its quantitative easing programme, while the ECB’s minutes of its December meeting suggests the central bank is preparing to cut its stimulus programme. In the minutes the eurozone’s ‘expansion’ was referred to, rather than ‘recovery’, which buoyed German bonds yields to two-year highs and boosted the euro-dollar cross by nearly 1%.
Low inflation environment
The era of high single digit or above inflation is the anomaly, Joshi said, noting that in history persistent rises in prices were rare. We are returning to a period of price stability, if credit booms can be avoided. Companies and consumers are not borrowing to the same extent of recent decades. Since the financial crisis, debt has been increasing in emerging markets like China, but Joshi sees that receding.
When it comes to wages, technology is affecting middle jobs, so the increase in employment is at the lower end service sector and this is holding down wage inflation.