Jonathan Shapiro has an interesting article in the Financial Review, Why the market has suddenly woken up to inflation, in which he writes:
…the lower-for-longer [interest rates] doubters are re-emerging. They believe deliberately slow-to-act central banks in the US and in Australia, stimulus cheques and pent-up spending will turbo-charge economic activity and unleash the inflationary forces many thought were gone for good.
Shapiro notes the bond market is starting to expect higher future inflation, with longer-term bond yields rising (e.g. check out the chart below). Higher bond yields, which mean higher borrowing costs for governments, will impact future government budgets and may force governments to make difficult decisions in a few years time as they face rising interest bills. However, central banks are keeping shorter-term yields (and, for now, home loan rates) suppressed through their traditional open market operations in the overnight cash markets and by Quantitative Easing – e.g. RBA purchases of three-year Treasury bonds in Australia (to target a 0.1% yield) and the RBA’s Term Funding Facility providing additional cheap finance to banks for business lending.
Given the states of economies worldwide, there is a lot of scepticism about current expectations of inflation, with CNBC reporting ‘This is not inflation’: Economist says expectations are unanchored from reality. That said, there’s little doubt we’ll see much higher inflation and interest rates eventually (especially given the trends examined in The Great Demographic Reversal). The big question is when.
Earlier this week, I spoke with Michael Knox, Chief Economist of Morgans, about his views on inflation and interest rates in his latest note The Fed – Allowing the economy to run hot. In his note, Michael observes:
The Fed has changed its inflation targeting policy to a longer run average inflation rate. The US likely gets back to full employment by 2023. After that, higher inflation may start a bond market bear market which will be hard to hold.
A bear market in bonds would mean a crash in bond prices and a surge in yields/interest rates, as the price and yield of a bond are inversely related. Michael Knox sees that happening after 2023 in the US and I expect we could see that repeated in Australia. To listen to Michael’s thoughts and his insightful and entertaining commentary on interest rates and inflation, check out our conversation which I’ve published as the latest episode of my Economics Explored podcast The Fed and Inflation Targeting.
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