jueves, 22 de mayo de 2014

jueves, mayo 22, 2014

Markets Insight

May 19, 2014 6:16 am

Fears over ‘lowflation’ serve up bond market surprise

Market positioning has turbocharged economic and policy factors


Rather than head higher and pierce the 3 per cent level, as virtually everyone had expected at the start of the year, the yield on US 10-year government bonds has touched its lowest since October. And, at just 2.5 per cent, it is not the only interest rate to behave in such an unexpected way.

German 10-year government bonds fell to 1.3 per cent last week, their lowest in nearly 12 months. And all this took place in the context of flattening yield curves (where long-end maturities outperform shorter maturities), another surprise.

Three major factors have come together to deliver such unexpected outcomes.

First, persistent concerns about the failure of American and European growth to “lift off” – including last week’s sluggish first-quarter eurozone data – have been amplified in recent weeks by spreading worries about “lowflation”. That is, inflation that is too low for too long and, as a result, risks pulling the rug from underneath inflationary expectations.

Perhaps nothing serves to signal such concerns more loudly than indications by the traditionally inflation-paranoid German Bundesbank that it would support the European Central Bank venturing deeper into unconventional monetary policy to counter lowflation.

Deflation threat


Second, central banks have signalled continued willingness to repress interest rates longer in order to stimulate growth and reduce the threat of deflation. The ECB is expected to introduce a new range of stimulus measures when its governing council next meets on June 5. Mark Carney, governor of the Bank of England, reiterated last week that he is in no rush to raise interest rates notwithstanding concerns about a booming housing market.

Meanwhile, across the Atlantic, while the Federal Reserve is phasing out its monthly asset purchases, officials are strengthening their forward policy guidance that seeks to keep interest rates abnormally low for an even longer period.

Third, market positioning has turbocharged economic and policy factors. Few traders were ready for lower interest rates, let alone a flatter yield curve. As such, the recent yield moves have triggered market stops, forcing them to buy bonds to limit their mounting losses. Meanwhile, the lower the interest rates, the harder it has become for some long-term institutional investors to remain underweight bonds given the longer-dated nature of their liabilities.

In theory, there is little to worry about as lower interest rates should be self-correcting on all three counts. By reducing mortgage rates, they increase house affordability and, for existing homeowners, the incentive to refinance mortgagesboth of which support home prices and housing activity. They also push investors out of bond holdings and into riskier assets.

Indeed, this is the main objective of the “unconventional policiespursued by major central banks, in the hope that the resulting price surge in risky assets makes households and businesses feel better, encouraging greater consumption and higher investment (via energisedanimal spirits”). Finally, offside traders’ positions get cleaned up as more are stopped out.

Having said that, the journey to low interest rates, and its volatility, warrant close monitoring. Sudden drops in interest rates raise concerns about the health of the global economy, leading to fundamentally-driven sell-offs in equities and other risky assets – a worry that is amplified by the extent to which the earlier equity rally had decoupled prices from more economic sluggish conditions.

Downside risk


In parts of the bond markets (away from high quality sovereigns), the greater the interest rate instability, the larger the technical downside risk to stretchedcarry trades” – given how yield-hungry investors have piled into high yield bonds, peripheral Europe and certain emerging markets. Such instability gets in the way of self-correction mechanisms. It can even assume a life of its own as unfavourable expectations become self-fulfilling.

While the next few weeks are likely to be volatile, western economies can still avoid the more disruptive path and, instead, regain the constructive self-correcting one. But this is far from a sure bet given the combination of stretched valuations, geopolitical risks from Ukraine, and the challenges China faces in negotiating a soft landing for its economy while reorienting its growth model.

This time, we should not look to another round of policy experimentation by hyperactive central banks as sufficient to stabilise markets, promote healthy growth and chop the tail risk of deflation. What is needed is a continuing healing of western economies, supported by a more balanced fiscal-monetary policy mix and deeper productivity-enhancing measures, including higher infrastructure investment.


Mohamed El-Erian is chief economic adviser to Allianz, chair of President Barack Obama’s Global Development Council, and author of “When Markets Collide”



Copyright The Financial Times Limited 2014.

0 comments:

Publicar un comentario