The death of the bond market has been predicted for many years as traders bet that central banks reflation efforts would finally bite, sending economic growth, inflation, and bond rates higher.
Now we might finally have the preconditions for the end to this long-term secular push lower in bonds given that markets almost universally expect the global economy, and central bankers, are trapped in a low growth, low inflation, and low interest rate trap.
It’s a trap which many, like RBA governor Glenn Stevens, believe the economy could be mired in because monetary policy has lost its efficacy and ability to alter the economic trajectory.
And that loss of monetary oomph could have sown the seeds for the end of the bond market rally and any increase in rates — and one group of analysts believes global financial markets, traders, and investors are not prepared for that moment.
The Nikko Asset Management multi-asset team floats the notion in their latest post on the company blog.
Nikko cites a comment from Peter Berezin, BCA Global Strategist, last month where he says “the rapid growth of populist political movements has increased the urgency for policy makers around the world to embrace reflationary monetary and fiscal policies”.
While such a move would be a political reaction to these populist movements, it would also align with growing calls from central bankers around the world that fiscal policy has a job to do.
Berezin said “the end result will be a drawn out ‘bottoming’ process in global bond yields, before a fiscal stimulus led synchronized global reflation spurs a new secular uptrend in yields”.
It’s an interesting theory.
Nikko says they’re not sure about the end to bond rally just yet, but says “what we agree with 100% is the reaction function of governments to poor opinion polls—they will do whatever is in their power to turn them around”.
They expect “a raft of populist policies to appease the disaffected masses whose voice had not been given attention until Brexit”.
It’s not just Britain. The rise of Bernie Sanders and Donald Trump in the US, plus more than 20% of voters backing minor parties in the recent Australian elections, and the rise of populist movements in other jurisdictions are symptoms of a lack of monetary policy effectiveness, and the likely catalyst for a renewed attention on fiscal policy.
Nikko says “by its very nature this policy will be reflationary, designed to lift the incomes of the majority of middle to lower class workers who have faced stagnant real wages for the past three decades”.
And that is where the danger lies for global markets, traders and investors.
Nikko says they aren’t sure “how successful such reflationary policy will be in producing sustainable growth, particularly given the deflationary headwinds of demographics, debt piles and excess savings”.
But the risk lies in the fact that it “is clear [is] that markets currently place the level of possible success at zero. Defensive trades are more crowded than ever”.
Wherever they look around markets the Nikko AM team sees “an investor base that expects a future of low growth and low inflation and is positioned accordingly”.
That’s dangerous, they say:
Markets are not prepared for inflation expectations to rise. If reflationary fiscal policy is able to turn the dial on future expectations for prices, the rush for the exits on some very crowded defensive trades could see some pretty extreme market movements.
We have been warned.