How times change. Back in late February, global stock markets wobbled amid worries over a weakening US economy. This instantly prompted talk of falling short- and long-term interest rates.
Then last week US, UK and European stocks slid by 2%, 2.6% and 3.6% respectively. Yet this caused no talk of falling rates. Far from it. Now everyone's fussing about higher rates.
Just look at what's happening in the bond markets...
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Last Thursday saw a dramatic sell-off in the US government bond market, with the yield on the 10-year Treasury posting its biggest one-day move for three years. It gained 0.13% (yields climb as bonds fall), breaking through the 5% mark, and finished the week at 5.12%. That sent UK 10-year gilt yields and 10-year Bund (German government bond) yields to nine and four-and-a-half year highs respectively. Clearly this is not a market that expects interest rates to fall any time soon.
So what happened? In the US Treasury market, the trend stopped being traders' friend, as John Authers points out in the FT. Bond yields have been falling for over 20 years thanks to growing confidence that inflation has been vanquished, but no more: as soon as the long downward trend line was breached by the 10-year yield moving above 5.05% traders started to lost confidence. Then they started selling indiscriminately. It looks like the long bond bull market is over. The Times cites bond guru Bill Gross saying he is now a 'bear market manager' after 25 years as a staunch bull.
As so often, there was no particular trigger for the 10-year yield's jump. 'An accumulation of evidence has reached critical mass', says Authers. Yields have been creeping upwards over the past few weeks as unexpectedly strong data in Japan, Europe and, more recently, in the US have implied higher interest rates. This week saw a number of Wall Street analysts ditch forecasts of a cut in US interest rates this year.
It is all about mood, says Breakingviews: inflation is back as a perceived risk. Central banks now look set to push up short-term rates to keep a lid on pricing pressure, implying higher bond yields. Higher corporate borrowing costs would not be great news for company earningswhich are already looking stretched given margins around record highs.
But a squeeze on credit markets would also threaten the easy money-based M&A boom, which in turn has been propelling stock markets to new highs. If debt becomes more expensive, it becomes harder for 'private equity groups to pay top dollar for publicly listed companies', as Richard Beales puts it in the FT.
That's a tad awkward as top dollar deal prices have caused such excitement of late. According to Siobhan Kennedy in The Times, firms are now paying 25-30% premiums or above to get deals done in the UK, up from 15-20% two years ago. It's also worth recalling at this point that fully half the British stock market's gains last year can be ascribed to M&A. We may be at the beginning of the end of the equity bull market, says Authers.
As far as the big picture is concerned, the markets' apparent new focus on the risk of inflation is long overdue. Hard commodities have been rising for years, and, given Asia's ongoing industrialisation and tight supplies, are set to keep rising for years. Moreover, as we have often pointed out in MoneyWeek, soft commodities also look due for a sustained upswing. Maize prices are 53% up on a year ago and milk prices are rocketing too; they are up 60% in New Zealand over the last 12 months.
In Britain overall food prices grew by almost 6% in the year to April, the fastest rate in six years. And spare a thought for Indian and Chinese households, grappling with food price inflation of 13% and 7% respectively.
While the world economy remains buoyant, British growth is also strong, house prices have only slowed marginally - annual growth is still around 10% - and companies have signalled their intention to put up prices. And the downward impact on goods prices thanks to cheap Chinese labour is ending; as Damian Reece notes in The Daily Telegraph, we are now 'importing inflation' as Chinese manufacturers try to recoup the extra costs they have been grappling with. What's more, the longer inflation remains above target, the greater the danger of people's expectations of inflation increasing and triggering a wage-price spiral.
So another rate rise last Thursday would have helped the Bank convince observers that they were serious about containing inflation. Now it just appears to be dithering. As Jeremy Warner says in The Independent, it 'better have a good explanation'.
Turning to the wider markets... In London, the FTSE 100 closed flat at 6,505 on Friday, having recovered from a morning low of 6,451. Banking stocks including Royal Bank of Scotland and Northern Rock performed well. But packaging company Rexam led the fallers after it confirmed it was in talks to buy US firm Owens Illinois's plastics division. For a full market report, see: London market close.
On the Continent, the Paris CAC-40 ended the day 7 points lower, at 5,883, and the Frankfurt DAX-30 closed down 28 points at 7,590.
Across the Atlantic, the Dow Jones added 158 points to end the day at 13,424. The tech-heavy Nasdaq added 32 points to close at 2,573. And the broader S&P 500 closed at 1,507, a 17-point gain. However, all three indices were down over the week as a whole.
In Asia, the Nikkei closed 55 points higher, at 17,834.
Crude oil had risen to $65.00 this morning and Brent spot was up to $69.72.
Spot gold had risen to $650.80 from $648.20 in New York late on Friday and silver had edged up to $13.14.
Turning to currencies, the pound was at 1.9673 against the dollar and 1.4733 against the euro this morning, and the dollar was at 0.7486 against the euro and 121.67 against the Japanese yen.
And in London this morning, shares in Barclays had risen by as much as 4.5% after a report revealed that the bank is facing investor pressure to drop its 64 million euro bid for Dutch bank ABN Amro Holdings NV. According to the Wall Street Journal, hedge fund and shareholder Atticus Capital LLV had met with Barclays to discuss shelving the deal.
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