Never say never

Article about Never say never

May 26, 2020

Two different stories

Since the bottom of March, the S&P 500 index has already risen by 32 percent. Lockdowns are being eased everywhere and the economic figures are gradually becoming less bad. The economy will certainly not flourish in the short term as in the period before the outbreak of the virus, but seems to have left the worst phase behind. Is the relief among investors justified? That is the question. After all, the bond market speaks an entirely different language. After the interest rate on 10-year government bonds in the United States reached an All-Time Low of 0.54 percent in March, it has hardly risen since then. The current interest rate on US Treasuries is 0.69 percent. The market is even taking into account a possible further lowering of interest rates by the Federal Reserve Board.

Bonds go their own way

So shares and bonds tell a different story, which is strange. In the past, rising interest rates invariably meant disaster for equity investors. Conversely, a fall in interest rates was greeted with cheers. However, this has not been the case since the financial crisis of 2008. Once interest rates are close to zero, any increase is more likely to be seen as favourable. It indicates a return to a more normal situation. Thus, since the credit crisis, interest rates and equities have always moved in the same direction. Rising share prices were accompanied by rising interest rates. During the recovery since March, this is suddenly no longer the case.

Inflation forecast drops rapidly

What is the bond market trying to tell us? That inflation will remain low for the time being. In fact, deflation is not even out of the question. For how else can we explain that 30-year government bonds in the United States yield only 1.3 percent? When the US economy was still flourishing before the crisis, the central bank already struggled to keep inflation at a level of around two percent. It is therefore not surprising that now that the economy is going down considerably, inflation is also falling rapidly. The inflation forecast for the next 30 years is only 1.1 percent.

Inflation stayed away

The market thus ignores the many experts who chorus the fact that the coming economic recovery will boost inflation. The enormous amounts of money pumped into the economy worldwide should inevitably lead to a degree of monetary devaluation. And that would oblige the central banks to raise interest rates again after a while. It could. But that was also claimed last time when the central banks tried to combat the credit crisis with large-scale financial injections. With all their might they tried to raise inflation to two percent. But inflation stayed away.

No price increase

And now what? Unemployment is running high everywhere. So there will be no collective wage increase for the time being. The commodity index is at an all-time low. The corona crisis has only accelerated the deflationary process of digitisation of the economy. In their fierce struggle for survival, companies will lower prices rather than raise them. Where should this price increase come from? In the United States, current inflation is currently no more than 0.3 percent.

Bull market not yet over

It could well be that this inflation wave, which many expect, will not happen for the time being. In fact, a general decline in prices - deflation - is more in line with expectations. The Federal Reserve is vehemently opposed to the negative interest rate policies of other central banks and says it will never do so. "Never say never". Bond investors in the United States outperformed the stock markets this year. Maybe the already 39-year-old bull market in bonds is still not over.

Articles authored by  Robert Jan Teuwissen

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