Bond Vigilantes: Key themes for global bond market in Q4

This is on the back of a resurgent US labour market, with the US having now recouped around half of the jobs lost during the Covid-19 pandemic.

While some economic data has softened a little in recent weeks, September’s Federal Reserve meeting suggests it is likely that tapering will begin by the end of the year, with more FOMC members now bringing their rate hike expectations forward from 2023 to 2022.

Despite the prospect of a looming tightening in monetary policy, moves in Treasury yields have been relatively muted this year. There has certainly been no repeat of the ‘taper tantrum’ of 2013, when 10-year Treasury yields spiked by around 120bps, peaking at 3% by the end of that year. As it stands, 10-year yields are currently around 1.3%, having drifted some way below a peak of 1.75% earlier in the year.

This appears to already be having an impact on recent economic data, such as a slowdown in US consumer confidence and weaker-than-expected retail sales in China. 

The outlook for inflation is the other key talking point, with opinion still divided as to whether the recent rise in consumer prices will be transitory or more permanent. 

While I am of the view that the structural drivers that have kept inflation low for many years – such as demographics, globalisation and technology – remain in place, I do think investors are right to be wary for perhaps the first time in many years.

US inflation has been well above target for several months, with CPI currently running at above 5%. While some of this is clearly due to transitory factors such as base effects and used car prices, it does appear likely that inflation will remain above target for at least the rest of the year. 

Importantly, we are seeing significant tightness in the US labour market, which if sustained could lead to upward pressure on wages and higher inflation over the medium-term.

Tapering is also a closely followed topic in the UK, with the Bank of England recently surprising markets by announcing that it would start reducing its stock of bonds once interest rates reach 0.5%, rather than the previously assessed level of 1.5%.

OECD warns against removing stimulus support despite rising inflation

Monetary policy in the UK could therefore start to be tightened sooner than previously thought, with markets now pricing in a first rate hike to occur in the second half of 2022. 

However, as with Treasury markets, moves in gilt yields have been relatively subdued, with 10-year gilt yields currently standing at around 0.8%.

In Europe, the ECB under its new President Christine Lagarde, has recently shifted its inflation target from ‘below but close to 2%’ to a more conventional 2% target. 

At the moment, the ECB has sent rather mixed messages as to whether this will involve flexible average inflation targeting, which would allow for a period of above-target inflation to make up for an earlier period of low inflation. 

The ECB at its September monetary policy meeting announced a moderate slowing in the pace of PEPP purchases, but it still looks like the major decisions on the future of the programme will be left until later meetings. 

Overall, it feels like more work needs to be done by the ECB to clarify its monetary policy strategy as we move into a post-pandemic world.

The relative calm of global bond markets this year suggests investors continue to believe that the recent rise in inflation will prove transitory, which in turn will allow central
banks to remove stimulus at a measured pace. 

The next few months are likely to be pivotal for determining the next steps for central bank policy and the trajectory of global bond markets in 2022.

Jim Leaviss is manager of the M&G Global Macro Bond fund 

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