Less than two months back, Louis-Vincent Gave, co-founder of Hong Kong-based research firm Gavekal had warned that rising inflation in the US could derail the rally in global equity markets. Gave was in the minority camp which was of the view that bond yields could rise despite the US Federal Reserve’s efforts to keep them in check through its bond purchases.
In an interview to The Market NZZ in December 2020, Gave had flagged the steady rise in bond yields and a parallel weakening of the dollar.
Ideally, rising yields should strengthen the currency as more investors buy the currency seeking better returns.
“Rising interest rates and a falling currency is a signal that investors are getting out, because they don’t like the policy setting,” Gave had said in the interview.
Gave also said that at some point the Fed would have to let yields return to pre-COVID levels. But that would put the Fed in a quandary as allowing yields to rise would increase its own borrowing costs. And forcing the Fed’s hand would the strong outlook on growth, as normalcy returned, bringing along with it inflation.
Yields on the 10-year US Treasury bonds have topped 1.5 percent, a level not many would have expected to see too soon. That in turn, triggered a selloff in equities as investors worried about the impact of higher borrowing costs on corporate profits.
Gave is of the view that growth will be very strong, and so will inflation, causing yields to try to get back up to 2 percent.
Capital flows into positive real rates just like water flows downhill. “…at which point the Fed will introduce some variant of yield curve control…or maybe the Fed freaks out when they see inflation rising to 4 percent, and maybe they decide to let yields rise,” he said.
Gave said that if the Fed capped yields at 2 percent, gold will thrive and if they did not, then financials will do well.
However, market is divided on whether inflation will be as strong enough to keep pushing yields higher.
“What the US bond market is saying is that I don’t like the potential trends in the deficits and in the debt rather than it being a case of worrying about inflation,” independent emerging markets commentator Geoffrey Dennis told CNBC-TV18 Dennis said, adding, “Against that background, the bond market might have wanted to see a little bit more reaction from the Federal Reserve this week.”
Sanjay Mookim of JP Morgan India too feels that central banks dovish stance will provide a strong support to equity markets.
“The one comfort that everybody has is that the central banks will continue to buy assets at a very great pace for the rest of the year and that should underpin equity market upside for some time,” said Mookim.
First Published: IST