Global bond markets have been twitchy in recent weeks – and during the second week of March, that twitchiness turned into a rout.
Over just two trading sessions, the yield on United States 10-year treasuries – a popular benchmark – jumped from 1.48% to 1.62%. Here in the UK, 10-year gilts also spiked sharply higher.
And when yields rise, don’t forget, that means that bond and gilt prices are falling: a fixed-income sell-off is under way.
It’s not difficult to see why a sell-off might be occurring.
Fixed-income investments – bonds and gilts – deliver, as their name implies, a fixed income. Compared to shareholder dividends, it’s an income that is more stable, more resilient, and more predictable – but also fixed: the price that you pay for a bond or gilt at the point of purchase determines the return that you get.
And that fixed return means that periods of inflation can sharply erode the real after-inflation income from holding bonds and gilts, making them less attractive to investors. Which is what’s driving the sell-off: fears of significantly higher levels of inflation.
Flush with cash
Markets – both fixed-income and equity – have in fact been twitchy about inflation since December. Again, it’s not difficult to see why.
Let’s start with household cash balances. The Covid-19 pandemic has had sharply different outcomes for many people.
Yes, the media is full of stories of people on furlough, and small business owners unable to open for business – think shops, pubs, restaurants, and so on. But many other people have continued to work, and find themselves building up significant cash reserves with little opportunity to spend that money.
Here in the UK, household cash balances rose sharply during 2020, increasing by another £21bn during December. That’s on top of some fairly hefty debt repayment, with household net debt falling by £16.6bn – a lot of it coming from outstanding credit card and mortgage balances.
The story is similar in the United States: in December, US household wealth hit a record $123.5trn, and again, credit card debt fell significantly, reducing by $149bn during 2020.
Put another way, when shops, pubs, and restaurants do eventually reopen, and it once again becomes possible to book holidays and visit car showrooms, an awful lot of people are going to find themselves with an awful lot of cash to spend.
Does that sound inflationary to you? It does to me.
Tsunami of money
Now on top of all that cash, let’s throw in the economic stimulus measures that governments around the world are launching.
Here in the UK, the latest Covid-19 support measures that chancellor Rishi Sunak announced in the Spring budget have seen 2021’s projected levels of government borrowing leap to £355bn – a level that is unprecedented in peacetime. Furlough payments, help for the self-employed, cash grants to shops and hospitality businesses, various business rates holidays, a lower rate of VAT for hospitality businesses: the chancellor’s largesse seemingly knows no bounds.
Over in the United States, President Biden’s $1.9trn stimulus package is just as generous. Europe, too, is getting in on the act. Governments everywhere are spending, trying to kick-start pandemic-ravaged economies.
Quite simply, it all adds up to a giant tsunami of money, heading straight for the economies of the countries in question.
And does a giant tsunami of money sound inflationary to you? It does to me.
So what does all this mean?
First, if inflation does indeed ratchet sharply upwards, expect bond and gilt yields to rise even higher – in other words, the sell-off will continue, until yields once again offer realistic real after-inflation returns.
And if sustained, that bond sell-off is going to see a lot money needing a home. I don’t know about you, but I reckon that this spells good news for share prices. Plus, unlike fixed-income assets, shares offer returns that have a degree of inflation-protection, further adding to their appeal.
Moreover, an inflationary environment will serve to make growth-centric shares relatively less attractive compared to income-centric shares – just as we’re seeing in the depressed valuations of several leading technology stocks right now.
The obvious beneficiaries of all this? Higher-yielding, boring, defensive consumer-oriented stocks – just as the consumers who are their customers find themselves flush with cash, adding further impetus to share price growth.
The message is clear: for investors, it’s going to be an interesting summer.