Why haven’t bond yields increased ?

A clever question raised by strategist at Nomura, and here are the summary of their answers… Enjoy

« Should government bond investors worry about a regime shift in medium-term inflation expectations? Probably not too much.

First, the scale of fiscal stimulus required to produce rational investors to predict a sufficiently large positive output gap to stoke a big increase in medium-term inflation expectations would be in the order of 2-4% of GDP over 2-3 years (that’s total not per annum) in the major economies. That is unlikely to be delivered any time soon. A more modest stimulus is probably unlikely to be credible in terms of shifting inflation expectations materially under rational expectations.

Second, even a more modest shift is unlikely to be delivered this side of elections in the US, France and Germany.

Third, regardless of the rhetoric of some finance ministers none have indicated a disregard for medium-term fiscal stability. This militates against the idea that credit risks will be taken with sovereign ratings.

Fourth, the unusual behaviour of PPI inflation for this point in the cycle allows a commensurately higher rate of domestic inflation pressures for any given overall inflation rate.

Fifth, growth at current rates appears to be sufficient to only generate modest positive output gap risks.

The burden in the next 6-12 months is therefore going to remain on central banks and the FX channel which is, from a global standpoint, sub-optimal in generating higher inflation expectations. For risk asset investors the message from the bond market continues to be bad for forward earnings expectations. As multiples return to reasonable, rather than stretch targets, earnings should come back to the fore. Return expectations should moderate as a result.

The euro area is back in the front line. Now.Casting.com tracking indicates a slowdown in growth has occurred for Q3 with spillovers into Q4. The output gap is at risk of reopening. Fiscal policy is most unlikely to do more than stand neutral for the time being. »

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