![\"10-year_core_government_bond_yields.jpg\"](\"http:\/\/www.next-finance.net\/http:\/\/beta.next-finance.net\/wp-content\/uploads\/2017\/02\/10-year_core_government_bond_yields.jpg\")
<\/a><\/p>\nIn our view, the bond-bubble was likely to burst, not because of a sudden acceleration in growth
\nor inflation, but because a change in policy would change the rules and shatter the complacency.
\nThe world is slowly adjusting to the idea that monetary policy will transition to stimulative fiscal
\npolicy. Trump\u2019s victory appeared an unlikely place for this trend to start, but it has set down a
\nmarker that will be difficult to contain.<\/p>\n
The disenfranchised middle-class has voted \u2013 negative rates and quantitative easing
\nare inadequate ways of raising their living
\nstandards. They want a new rule book. And if
\nthe current political establishment is unwilling
\nto rewrite the rules, they will soon be voted
\nout of office in favour of someone who will.
\nFor some time, markets have become
\naccustomed to thinking that any disappointing
\ndata on growth and inflation would be met by
\nlower rates or quantitative easing.<\/p>\n
But these tools have been increasingly used
\nas last-ditch efforts to spark economic growth.
\nAs we reach the end-game for monetary policy,
\nthere is now an acknowledgement that central
\nbanks soaking up a dwindling supply of bonds
\nhas a number of detrimental side effects.
\nMore spending and tax cuts appear to be the
\nway forward, yet fiscal stimulus is inflationary.
\nThis would be negative for bonds in a normal
\nenvironment. Coming from a bubble-like
\nstarting point, it\u2019s even more ominous.<\/p>\n
With the collapse of long-dated interest rates
\nin mid-2016, bond markets had been pricing
\nin little inflation risk for at least the next
\ndecade. But with the rule change we expect,
\nterm premia is likely to normalise and the
\nidea that investors should price-in permanent
\ndisinflation will fade into obscurity. In that
\nenvironment, a continued sell-off in bonds
\nis likely.<\/p>\n
If all of Trump\u2019s agenda becomes law, the bear One: Inflation expectations<\/strong><\/p>\n If fiscal stimulus becomes the policy lever Two: China<\/strong><\/p>\n China should be watched very closely. Longdated China\u2019s economy has been slowing. A savings Three: Europe and geo-politics<\/strong><\/p>\n What happens in Europe, from a geo-political A continued political shift to the right would Conclusion<\/strong><\/p>\n The bond bubble is bursting. How spectacular We believe inflation expectations will continue We envisage policy rates staying lower forThe bond bubble is bursting.
\nHow spectacular will it be? That
\nremains to be seen, as there
\nare many deflationary forces
\nstill bubbling just beneath the
\nsurface.<\/quote><\/p>\n
\nmarket will have much further to run.
\nWith this in mind, we believe investors should
\nlook out for three key signals that might tell us
\njust how far bond yields might rise.<\/p>\n
\nof choice, we would expect an inflationary
\nreaction. \u2018Fiscal\u2019 means more spending, which
\nshould boost growth as well as increasing
\ndeficits. Growth and inflation, if combined with
\nderegulation (which we expect with a Trump
\npresidency), spurs corporates to spend more and that can create a virtuous circle that\u2019s
\nvery bond-negative. But inflationary
\nexpectations are also a function of wage
\npressures and trade protectionism. We\u2019re at
\nclose to full employment in the US, and wage
\ngains could start to push higher given that
\nlabour markets are tight and a high number
\nof people that have left the workforce are not
\ncoming back. Wage pressures, along with fiscal
\nstimulus and a more protectionist agenda
\n(which is itself inflationary through trade tariffs
\nand immigration), will see inflation expectations
\ncontinue to rise from what are still
\ndepressed levels.<\/p>\n
\nglobal rates reflect a decade-long series
\nof capital outflows from China. The central
\nbank has purchased hundreds of billions of
\nforeign bonds. This bond-buying programme
\nis a function of years of over-investment in
\nplants and equipment, which itself led to overproduction
\nand excess capacity. China\u2019s capital
\noutflows put immense downward pressure on
\nglobal real rates and term premia.<\/p>\n
\nglut, sluggish business investment and worries
\nover potential devaluation in the yuan have all
\nprovided the impetus to move money offshore.
\nBut if the Chinese economy were to merely stabilise, it would provide yet another catalyst
\nfor bonds to sell off. A surprise reacceleration
\nin China would force foreign flows to rapidly
\nrecede, leaving global government bonds
\nwithout a key source of demand. Somewhat
\nworrying is that there are some signs that this
\nis happening, just as Donald Trump is set to
\nenact some of his policy proposals, though this
\nis something of a coincidence.<\/p>\nIf fiscal stimulus becomes the
\npolicy lever of choice, we would
\nexpect an inflationary reaction.<\/quote><\/p>\n
\npoint of view, will be critical. In 2016, we have
\nalready seen the UK vote to leave the EU and
\nthe electorate reject the Italian prime minister
\nMatteo Renzi\u2019s referendum proposal. In 2017
\nwe have elections in France and Germany, not
\nto mention Article 50 being invoked.<\/p>\n
\nimply that more populist policies will continue
\nto be enacted. There are limits in Europe as
\nto the scale of any tax cuts and increases
\nin spending that can be delivered, because
\nfiscal policy is limited by the Maastricht
\nTreaty, which caps member state
\ngovernment deficits to 3% of GDP (and public debt levels to 60%). However, if populist
\nparties who claim they will breach these rules
\nare elected, this raises the risks surrounding
\nthe eurozone project. Ironically, in Europe, this
\nis a recipe for higher rates overall, rather than
\nlower rates.<\/p>\n
\nwill the sell-off be? That remains to be seen,
\nas there are many deflationary forces still
\nbubbling just beneath the surface, and a
\nplethora of policy uncertainties. Trump will
\nalmost certainly succeed in getting tax cuts
\nthrough and a scaled down version of his
\ndefence and infrastructure spending package
\npassed. China is stabilising and with it comes
\nless of a reliance on their easy monetary policy.
\nCapital outflows will likely diminish as the yuan reprices and the powerful force of central
\nbank buying \u2013 either through investment or
\nQE channels \u2013 will recede. With respect to
\nEurope, it is very difficult to forecast, but it
\nwould be wrong to extrapolate what happened
\nin the UK with Brexit (as well as the election
\nof Donald Trump and the Italian referendum).
\nNonetheless, the previously unthinkable is
\nnow possible.<\/p>\n
\nto rise from what are still depressed levels.
\nThe US economy is near-full employment.
\nWage inflation coupled with even modest
\nprotectionism and the prolonged recovery
\nshould create elevated inflation expectations.<\/p>\n
\nsome time in Europe as there is still enough
\nuncertainty \u2013 not just geo-political risk, but also
\nconcerns over the strength of some economies
\nin the region \u2013 for central banks to continue
\nwith a \u2018lower for longer\u2018 policy. Rate rises are
\nalso unlikely in Japan, which leaves the US
\nas something of a focal point. On the back of
\nincreasing wage pressures and fiscal spend,
\nwe expect rate hikes in 2017 to follow the
\nDecember Fed hike. The tide has turned.