Summer is usually quiet for markets, but I wonder if we might look back and see this week – Tuesday in particular – as a turning point. Why? Because it may well mark the day when the last of the big money printers – the Bank of Japan – began to turn off the taps. In late 2016, the Japanese central bank told markets that it would do whatever it needed to in order to keep the yield on ten-year Japanese government bonds (JGBs) at 0%. By and large, the yield has stayed at 0% ever since. But with US interest rates rising, and the end of quantitative easing in sight in the eurozone, investors had started to wonder if the Bank would change policy at its July meeting. Which is what it did.
The Bank now says it will let the ten-year yield rise to as much as 0.2% – rather than 0.1% – before it intervenes to drive it back down. Bank boss Haruhiko Kuroda tried to downplay the move by noting that rates will be very low in Japan for years. Yet the market took the hint. As we went to press, JGB prices had seen their biggest fall in two years (bond prices fall as yields rise). It’s not much of a tightening to be sure – but it is certainly not a loosening.
And this is the key point to understand. Interest rates are still incredibly low, and likely will be for some time. But that’s not the point. The point is that the direction of travel has changed. Up until July 2016, investors still feared that the global economy would plunge back into deflation and that central banks would have to print lots more money. In the immediate wake of Britain’s vote to leave the European Union, investors even bought 50-year Swiss government bonds at negative yields (so they paid the Swiss government for the privilege of lending to it). Yet the world didn’t end. Indeed, growth has been largely solid and inflation is perking up. So for now at least, markets are realising that the only way is up, rather than down, for rates.
We’re already seeing the side effects. Alongside bonds, one asset class that made huge gains from falling rates is global property. Today, house prices in markets from London to Australia and the US, are stalling or falling. Rising rates means less money is available for mortgages, and thus one of the key drivers of higher house prices has vanished.
But what might benefit from this major change in the backdrop? Well, as Ben Inker of GMO noted late last year, if inflation is a looming worry, then emerging-market companies might be worth a look – because unlike developed-market firms, they’re already well used to inflation. Better yet – they’re cheap. Check out Rupert Foster’s cover story for ideas on how to invest.