Exposure rates of the Dorval Asset Management Range – 10th December 2021

The US inflation question continues to add fuel to the fire in debates between economists, but the financial markets are not budging. Long-term yields have even dropped somewhat in western markets over the past two months, making for something of a mystery.

US core inflation – i.e. excluding food and energy – dipped slightly again in November (+0.5% over the month vs. +0.6% in October), although it still remains high (cf. chart 1). Some sectors continue to drag on figures, such as real estate and automotive, but it is still too early to determine a plausible projection on the real pace of core inflation, as both Covid and bottlenecks continue to make their presence felt.

 

US core inflation still high, but not quite as lofty as October
Monthly change in US consumer prices, as a %

Core inflation (i.e. excluding food and energy)
Core inflation excluding real estate and used cars

 

 

However, the bond markets are most definitely holding their ground. A far cry from urging central banks to wave in more restrictive monetary policy and shield them from inflation, investors continue to buy long-term bonds with yields well below inflation. These yields have actually even slid again recently (cf. chart 2), perhaps as a result of the fifth wave of Covid-19, along with the new Omicron variant. Yields on the 30-year sovereign bond in western markets have virtually revisited levels witnessed at the start of the year.

 

Yields on 30-year bonds have dipped again since mid-October

US bonds
UK bonds
German bonds

 

 

The economic boom and surging inflation have held no sway over the long-term bond market this year, a situation reminiscent of Alan Greenspan’s famous conundrum, when the Fed’s rate hikes between 2004 and 2006 made no dent to long-term bonds – quite the opposite in fact. However, real rates were broadly positive at the time.

 

Some analysts may see sluggish long-term yields as an indication of investor pessimism on the structural growth outlook. Meanwhile others will argue that lethargic bond yields are a result of these bonds being largely held by the central banks themselves. Lastly, projections of a slowdown in US growth in 2022 may well be driving purchases of safe haven assets, including government bonds.

 

One thing is sure – the threat of a sharp surge in long-term yields in 2021 did not materialize, fueling stellar showings on world stock-markets. We will see how the complex – and sometimes impervious – interactions between economic growth, the pandemic situation, inflation and interest rates pan out in 2022. But for now, we maintain our constructive view of the equity markets, as the world share indices continue to surf the ongoing profit boom and benefit from composure on the bond markets.

 

 

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