George Lucas, Raiz Group CEO
It wasn’t the most eventful week in markets. The US Treasury bonds continued their selloff on the back of US President Joe Biden pushing through his $1.9 trillion economic stimulus plan and the news that the US vaccination program against COVID-19 will be accelerated.
Looking a bit deeper, the underlying reason for the selloff is likely fears that inflation may increase in the short term, which is probably true. However, we’re not looking at 1970s style double digit inflation at present, with inflation more likely at 4 percent or 5 percent in the short term.
Equities maintain calm amid choppy bonds market
Interestingly, the increase in volatility from the bond market didn’t flow into the equity market. The reason could be that equities are being viewed an okay place to hold money if inflation kicks in as companies’ earnings may increase, keeping up with rising inflation.
Separately, we also saw a bit of a lift in the price of Bitcoin (BTC) as more and more investors now see it as a possible inflation hedge, with BTC pushing past $78,000 a coin for the first time this week. But only time will tell if this analysis is correct.
US Fed likely to maintain dovish tone, for now
I suspect the US Federal Reserve will continue trying to convince investors that its “reaction function” is more dovish now than it was before the pandemic, following the new policy framework for average inflation targeting that it adopted last year.
Simply put, this means a short term rise in inflation should not cause the Fed to tighten policy. This fits with recent messaging from US Fed Chair Jerome Powell reassuring equity markets that the Fed is not close to retracting its economic support, despite prospects of an improving US economy.
The expectation that the Fed will not alter policy if inflation rises in the short term is probably another reason we have not seen a recent increase in volatility in the equity markets.
ECB plans to ratchet up bonds buying
At the same time as a selloff in US Treasury bonds, this week saw the European Central Bank (ECB) announce that it will accelerate its purchase of bonds.
ECB President Christine Lagarde stressed the Frankfurt-based institution’s commitment to maintaining favourable financing conditions further during her press conference. The ECB’s bond purchases in Q1 have been lower than usual and it said it plans to ramp up purchases going forward.
On the back of this, yields of 10-year eurozone government bonds fell, which is a stark contrast to what is happening in the US markets.
Bank Indonesia rate decision looms
In Asia, Bank Indonesia (BI) has a rate decision on Thursday. I think it should cut rates by 0.25 percent based on strength of the nation’s economy, but it is now harder for it to do that with the rise in interest rates in the US. Its benchmark rate currently sits at a record low of 3.5 percent.
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