Analysis: overhaul of reflation tilts bond markets



The front facade of the New York Stock Exchange (NYSE) is seen in New York, United States, February 16, 2021. REUTERS / Brendan McDermid / File Photo

LONDON, July 7 (Reuters) – An economy recovering from the shock of COVID-19 and resurgent inflation is yesterday’s story based on the strong recovery in the world’s largest bond markets. world in the last 24 hours.

Prices for 10-year US Treasuries soared, pushing yields down 8 basis points on Tuesday in their second largest daily decline of 2021. The recovery accelerated on Wednesday, with yields falling just below 1.3%, their lowest in more than four months.

UK Gilts yields fell to a similar level while German Bund yields – which looked set to exceed 0% in May – fell to -0.3%.

Various explanations have been put forward: a squeeze in investors who had bet on higher yields, weaker-than-expected economic data, and concerns about COVID variants.

Exceeding the noise and the real message of sovereign bond markets – closely watched by policymakers and investors as a key indicator of economic trends – is clear: economic growth, while firmer, appears to have peaked, and all pick-up in inflation is likely to be transient.

“Markets have gone from thinking growth is strong and inflation could be strong to saying growth has peaked and inflation is transient,” said Guy Miller, chief market strategist at Zurich Insurance Group.

The downturn in bond markets may not fit with the message from the US Federal Reserve, which has just shifted to a hawkish bias and advanced its rate hike path.

But even with this change, the Fed does not expect to start raising rates until 2023 and, like other major central banks, has stressed that it will look beyond any short-term increase in pressures on prices. price.

“You have to change your mind given the facts you are facing – economic growth is not strong, inflation is not about to soar,” said Frederik Ducrozet, Pictet Wealth strategist. Management.

The bond rush comes as data reinforces the view that economic growth may have peaked.

Data on Tuesday showed that activity in the US services sector grew at a moderate pace in June, while a closely watched indicator of German investor sentiment fell more than expected in July. Read more

The bond rally would have inflicted losses on the multitude of traders with “short” Treasury positions – essentially a bet that yields would rise alongside a recovering economy – forcing many to liquidate those trades, pushing yields even lower. Read more


Many investors, including the world’s largest asset manager, BlackRock, have been bearish on Treasuries. BlackRock reiterated its bearish bet on Wednesday. Still, yields have seen a steady 50bp decline since March.

The explanations for this slide vary; some cite demand from Europe and Japan where central banks are resolutely accommodating. Others point to the liquidity swirling around the U.S. financial system as the Treasury spends its cash balance and the Federal Reserve sucks up $ 120 billion in bonds each month.

But it may also be that despite a seemingly dynamic economic recovery, bond markets have had doubts about the outlook; The lower yields are mainly due to “real” or inflation-adjusted borrowing costs, ING Bank analysts said in a note.

US 10-year real yields have fallen to minus 1%, the lowest since February, while German real yields are at their lowest in three months.

According to Mike Sewell, portfolio manager at T. Rowe Price, the US 10-year nominal yield level of 1.77% hit in March could remain the highest this year as more bets on ‘reflation Are forced to unwind.

“There is still potential for re-engagement of this trade, but it is more of a 3rd or 4th quarter potential. Right now the reflation trade is not dead but it is certainly in hibernation.” , Sewell said.

Two other factors can contribute to nervousness.

First, China, the world’s second-largest economy, also released data this week showing service sector growth is slowing to its lowest level in 14 months. This, according to some analysts, is a model for how developed economies will fare.

Second, more countries – including China – are seeing a resurgence in the number of COVID-19 cases and concerns are growing about new, potentially more infectious variants.

The Delta variant, now dominant in many countries, including the United States, is spread more easily than previous versions of the coronavirus.

“The muscle memory of the markets is that governments will lock in again if they see cases increase, which means slower growth and we’re caught in a loop,” said Charles Diebel, head of fixed income. at Mediolanum International Funds.

Reporting by Dhara Ranasinghe, additional reporting by Sujata Rao and Karin Strohecker in London and David Randall in New York; Editing by Sujata Rao and Nick Tattersall

Our Standards: Thomson Reuters Trust Principles.


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