"Back in the Spotlight" - Yields Back in Focus | Economics Global

As yields and commodity prices rise around the world, the combination has led to the fuelling of inflationary concerns among investors.

As global yields and commodity prices continue to rise around the world, and as various countries continue to implement monetary and fiscal stimulus programs, the end result has led to the fuelling of inflationary concerns, and market jitters, among investors. Though we do think that these concerns are a little overblown, a near-term increase in inflation could still prompt volatility in global markets. In the months ahead, though we do believe investors will need to “batten down the hatches” in the face of market volatility, our call for the cyclical recovery this year still continues to stand.

Market expectations for US inflation over the next two years has reached their highest level since May 2018, with the US 10-year breakeven inflation rate rising to 2.18% as of February 2021. Though this is an indication that inflation is around the corner, we don’t see persistently higher price pressures in the near term. This is due to the fact that there is still considerable slack in the (global) economy, as we don’t expect global GDP growth to regain its trend until the end of this year.

Nevertheless, a near-term bump in inflation is most certain given the current macro environment. At some point, over the next few months, investors will face a combination of rising inflation, as well as strong economic momentum, while central banks continue to add liquidity and keep interest rates close to zero. Given this high level of macro uncertainty, periodic spikes in volatility should be expected. For investors still willing to ride out the spikes, we believe these are a few things that should be should kept in mind:

Get Ready for a Weaker Dollar 

We do expect to see a weaker US Dollar over the mid-term, as the currency remains overvalued in the face of emerging pockets of global growth in Europe and Asia. The number of investors in US-denominated financial assets, as a proportion of total fixed income and equity market capitalization, now stands at its highest level not seen in the last two decades. This indicates the potential for the sales of US-denominated assets as investors seek to hedge or diversify their dollar exposure(s). Once vaccine rollouts allow European and Asian countries to lift restrictions on social activities, the current growth gap between the US and the rest of the world will shrink substantially. A strong, sustainable global recovery should benefit more pro-cyclical currencies such as the South Korean Won, the Euro, the Australian Dollar, and the Chinese Yuan, alongside a corresponding decline in demand for safe haven assets such as US Treasuries.

The Hunt for Yield Continues…

While global central banks continue to keep interest rate hikes on hold, despite inflation rising in the quarters ahead, we are looking to the riskier areas of the fixed income markets in search of positive returns over the next few months. However, it is acknowledged that market risks are shifting at the moment. Any further compression in Emerging Market sovereign and corporate bond spreads is now more concentrated in the lower quality credits (CCC and below), thus increasing the idiosyncratic risks associated with this area of the fixed income space. Thus, for investors who are interested in this area of the credit markets, though we do believe opportunity can be found, investors should do their due diligence. In terms of global high yield, we do like this area of the credit markets, as the average credit quality of global high yield bonds has improved thanks to new bond issuances, as well as the entry of “fallen angels” into the mix.

Conclusion

Going forward, we (still) retain a favorable view of markets for 2021. While the abrupt spike in rates will lead to increased market volatility, we don’t think this will prevent the markets from moving higher. Nonetheless, investors looking to protect and/or grow their wealth will need to have a plan to put their excess cash to work, especially if the prevailing stimulative, low-rate, and rising-inflation environment continues.

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© 2020 Economics Global Inc.

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