Warning bond and equity market sell-off has further to run as inflation fears build
10-year Treasury yields widened to 2.73%
Managers have cautioned the sell-off in both bond and equity markets has further to run, pointing to the impact of the withdrawal of central bank stimulus and even a potential stagflationary environment developing.
Concerns over central bank policy and higher-than-expected inflation caused global bond markets to sell off on 29 January with 10-year Treasury yields rising to 2.73%, their highest point since April 2014, while two-year Treasury yields reached the highest level since September 2008, climbing to 2.16%.
Furthermore, in Europe five-year German bund yields moved into positive territory for the first time since November 2015.
Fears of contagion risk have subsequently spread to equity markets with the S&P 500 suffering its worst weekly performance in two years last week, falling 3.9%, while the Dow Jones lost 4.1%. In early trading today, the Dow Jones is down 1.06% at 25,249.46 while the S&P 500 is down 0.77% at 2,740.89.
Inflationary pressure
US equity markets have been in a euphoric state since President Donald Trump passed his historic Tax Cuts and Jobs Act reform, which saw corporation tax cut from 35% to 21%.
This pushed the S&P 500 up 5.9%, marking its best start to the year since 1987, prior to the recent pull-back.
However, Paul Warner, senior portfolio manager at MitonOptimal, said the reforms could add to rising inflationary pressures, which are already being driven by wage growth acceleration and higher oil prices.
Furthermore, the Federal Reserve - in Janet Yellen's final meeting as chair - was more hawkish than in previous meetings, increasing the likelihood of an interest rate rise in March.
In a statement following the two-day policy meeting, the Fed said "inflation on a 12-month basis is expected to move up this year", predicting it will stabilise around its 2% target over the medium term.
"You are beginning to see the edge taken off the US economy as capacity has disappeared," Warner said.
"I would not be at all surprised if bond yields get beyond 3% by the end of the year as a result of inflation.
"If there is going to be a recession, it will be next year, not this year, but there could be a slowdown in the US economy as inflation is picking up, which could lead to stagflation in Q2 and Q3," he said.
"This will be bad for bonds and mediocre for equities. Our biggest fixed income exposure is through the Royal London Short Duration Credit fund, which acts as protection against this rising inflationary environment."
