We expect China’s bond market to diverge from those elsewhere

We think China’s long-term government bond yields will continue to fall as the country’s economy slows further, even if yields rebound elsewhere.

2 August 2021

We don’t expect the rally in bond markets to continue

While long-dated government bond yields have plummeted in recent months, we suspect that high inflation and the prospect of tighter monetary policy will see them turn a corner before long. We forecast long-term yields to rise across most major economies, especially in the US, where inflationary pressures look particularly strong. Higher yields may also help limit the upside for risky assets, such as equities and corporate bonds. Their valuations already appear fairly stretched in many cases. And when it comes to equities, an extremely strong rebound in corporate earnings already appears to be discounted. As a result, we forecast only small gains in equities across both DMs and EMs, and expect credit spreads to narrow only a little, if at all, from here.

30 July 2021

Investors refocus on long-term concerns

Questions about the strength of China’s post-lockdown rebound have become louder since the People’s Bank cut the required reserve ratio three weeks ago. But the trigger for this week’s sharp equity market sell-off was instead growing disquiet about the leadership’s commitment to open and free capital markets. The MSCI China index is now discounted relative to developed market equities to a degree that has not been seen since 2014/15, with the exception of a brief spell last year. Officials insist that it is only the private education sector that they want to crush but, even if investors accept that, the episode brings into focus the political risk associated with investing in China and it underlines the leadership’s ambivalence towards markets. We think this will take a toll on economic growth over the medium term. And we expect it to weigh further on equities too.

30 July 2021
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Bond market pessimism looks overdone

The US yield curve continues to send a gloomy message, which we think is hard to square with the economic outlook.

Re-opening should more than offset wildfire disruption

The wildfires in British Columbia appear to have been more disruptive than we first thought, but GDP should still rise this month thanks to the easing of the coronavirus restrictions. The volume of rail freight carloads carried across the country plummeted at the start of the month and have remained weak since then, as the wildfires in British Columbia have closed some key rail routes into the Port of Vancouver. The decline in rail freight has been even more pronounced than during the early 2020 rail blockades and suggests that rail transportation GDP could fall by as much as 10% this month, with knock-on effects on some industries including farming, mining and manufacturing. That said, the direct effect of even a 10% decline in rail transportation would still be just 0.05% of total GDP and the overall impact of the disruption seems unlikely to be more than 0.2% of GDP. That should be more than offset by the gains from the re-opening of the economy, with the surge in restaurant visits alone pointing to a rise in GDP of 0.2%. Nevertheless, the wildfire disruption means the risks to our forecast for third-quarter GDP growth of 8.5% annualised now lie to the downside, and the further disruption to supply chains could lead to more upward pressure on inflation over the rest of the summer than we currently expect.

We think US real yields are unlikely to stay this low

The yields of long-dated US Treasuries have edged down this week, and those of TIPS have dropped to a new record low, but we still expect both to recover over the next couple of years.

We doubt global saving will stop US yields from rising

In the early 2000s, a ‘glut’ of global saving may have helped restrain rises in long-term US bond yields, even as investors began to discount tighter monetary policy. We don’t think that similar factors explain the latest fall in yields, nor do we expect them to prevent yields from rising over the next couple of years.

The ECB’s new guidance and its implications for E-Z bonds

We don’t think the changes to the ECB’s guidance announced today or the Bank’s recent strategy review materially alter the near-term outlook for government bonds in the euro-zone. However, they make us even more confident in our view that the yields of euro-zone government bonds will rise only gradually over next few years and that “peripheral” spreads will remain low.

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