How excited the equity and bond market became last month with the idea that economic growth was starting to be reflected in the inflation data, central banks were becoming more hawkish in their comments and rates would start to normalise slowly over time. This excitement focused on the king dove, Mario Draghi, and his comments. A month later Inflation around the globe looks like it will slip back again, 10-year US treasury yields hit 2.4% is now back to 2.25%. The market is now pricing in the very little chance of a rate rise in September and less than 50% chance of another move this year by the Fed. The Bank of Japan added to the sudden change in inflation sentiment that has taken place in the past week by announcing, after their two-day meeting that they too will be maintaining their current monetary policy whilst lowering their inflation expectations for the next two years.
Equity markets have taken all this dovish rhetoric to heart and equity markets have been rising once again around the globe. Goldilocks is alive and well low-interest rates, modest inflation and according to most analyst’s global economic growth in the coming couple of years of circa 3%. Can it be that simple? Possibly it is, a perfect concoction for equity markets to grow in. As my father says if it seems too good to be true, it probably is.
On the plus side equity markets tend to fall when the fundamentals get ahead of themselves at a point in time when the central bankers are trying to control economic growth. Currently putting the brakes on growth is not something any of them want to do.
The question the central bankers and the equity market may start to ask is why inflation just does not want to reappear back into the global economy. Central bankers have flooded the world with money, employment rates (less so in Europe) have fallen back to lows, look in any economics text book and they would suggest that this is a perfect mixture for inflationary pressures.
Bill Gross in his monthly letter highlighted that the yield curve has been flattening, something we too have highlighted in this piece. In his view, the world’s indebtedness is such that a much smaller change in short term rates could have a far greater effect than historically would be the case. Everyone has been focused on the idea that equities would fall when yields rise as central banks reduced liquidity. The stock market can be like a magic trick whilst the audience is distracted one way the other hand is where the action is.
Greece was hoping to come back to the debt market this week, investors may want to yield they are not quite ready if it's Greek. Perhaps if they thought Mario Draghi might take it off their hands they may be tempted. However, at this moment in time, Greek debt is not even on Mario Draghi’s shopping list.