AMP chief economist says the 30-year bull market in bonds is likely to be over, but the probability of a sharp spike in bond yields is still low.
Benchmark US 10-year bond yields — which rise when bonds are sold — are holding at multi-year highs this morning above 2.7%, after the US Fed kept rates on hold last night but took a more optimistic view towards US economic growth.
That means markets are still pricing in at least another three rate hikes this year in the US, with the first one scheduled for March.
“Higher US inflation and a more aggressive Fed will likely boost volatility this year,” Oliver said.
“However, the back up in bond yields is likely to remain relatively gradual, and other countries including Australia will lag the US.”
In view of that, Oliver highlighted a number of reasons why fears of a “perfect storm” have been overdone.
In analysing the 30-year bull market in bonds, Oliver noted that structural factors had also served to keep inflation low in that time.
That’s largely been due to stimulatory monetary policy by central banks, and the downward pressure on prices from globalisation due to cheaper labour costs.
But Oliver said that historically, when bond yields start to turn higher after a sustained down-trend, the pickup has usually been gradual — as evidenced by the circled areas in the below chart:
Oliver added that central banks in Europe, Japan and Australia remain some way behind the US in their rate tightening cycle.
And while the latest data indicates signs of a tightening US labour market, “global inflation is unlikely to take off too quickly given spare capacity in labour markets (in Europe and Australia) and technological innovation continuing to constrain inflation”, Oliver said.
Some analysts have also expressed concern that the negative effect of rising interest rates will be exacerbated, given that the global economy is swimming in a record $US233 trillion of debt.
But Oliver poured cold water on the argument:
The idea that high debt levels mean that central banks will either have to live with a debt crisis or much higher inflation is nonsense.
High debt levels just mean that interest rate increases are more potent than they used to be – so when inflation does start to become an issue, they won’t have to raise interest rates as much to bring spending and inflation back under control than was the case in the past.
In assessing the implications for equity investors, Oliver expects stocks to perform well this year as higher earnings outweigh the gradual pickup in bond yields — a view shared by Capital Economics economist John Higgins.
However, stocks that investors buy for a consistent dividend yield, rather than capital growth, such as real estate investment trusts and utility companies are likely to underperform.
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