By Dhara Ranasinghe
LONDON- Federal Reserve: 1, bond markets: 0. That’s more or less where it stands after Round One in the tussle over borrowing costs. But Round Two, and perhaps even Round Three, are inevitable, and they may require policy action rather than just words.
February’s bond selloff sent US 10- and 30-year Treasury yields more than 30 basis points higher while governments from France to Australia saw their borrowing costs jump. Stock markets, which for years surfed the cheap-money wave, tumbled.
The selloff was driven by concerns that adding enormous buckets of government spending to a fast-recovering US economy would push inflation above the Federal Reserve’s target sooner than anticipated.
In theory, that would force the Fed’s hand in raising interest rates, wiping out investors’ bond market returns.
In reality, a lasting inflation rise is likely years off — Fed boss Jerome Powell reckons three years. Central banks have also repeatedly indicated they will keep rates below inflation.
Reiterating such messages, alongside interventions by smaller central banks such as Australia and South Korea, calmed bond markets. Bets on early-2023 Fed rate hikes have ebbed.
But perhaps markets are regrouping before another assault.
“Fed members have signaled they are not worrying, so the bond market is saying: ‘If this is not your pain point, we’re going to find out what is’,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.
Markets facing off against central banks is nothing new and the old adage “Don’t fight the Fed” still holds. But market clout has grown too.
As of 2019, funds’ assets worldwide totaled $89 trillion, dwarfing the combined $25 trillion balance sheet of the biggest central banks and surpassing global economic output.
Central bank stimulus that crushed borrowing costs to below inflation has fed an equity bull run that has added $64 trillion to the value of global stocks since 2008. Higher yields would put that entire edifice at risk.
The shifting power balance became evident in 2013 when a market tantrum forced the Fed to backtrack on plans to start withdrawing stimulus. Another market revolt erupted in late 2018, egged on by then President Donald Trump. The Fed soon pivoted from raising rates to cutting them. – Reuters