Financial repression “reloaded” and massive government debt could drive up long-term yields
Given the support that central banks pledged in the face of Covid-19, we expect short-term interest rates to remain at ultra-low levels for the foreseeable future. This is essentially a “reloading” of the financial-repression policies (including low interest rates, restricted capital flows and other regulations) that central banks implemented after the financial crisis to help their economies grow their way out of debt. In our view, continued intervention by central banks is necessary, but it could still lead to higher inflation and other problems in the medium to longer term. In addition, a huge supply of sovereign bonds – the direct consequence of extremely expansionary fiscal policy – will continue to flood the bond markets in the coming quarters.
What does it mean for investors?
- All this supports our idea that the US yield curve in particular is likely to steepen – meaning that the difference in yields between longer-dated bonds and shorter-dated bonds would widen. (Bond prices and yields move in opposite directions.) While curve steepening could take place in various ways, we think the most likely scenario is that yields for long-dated bonds rise while those at the short end of the curve remain basically unchanged.
- Another argument in favour of curve steepening is that we don’t expect most major central banks to mirror what the Bank of Japan has done and implement yield-curve controls with bonds of different durations – targeting not just those on the shorter end of the curve, but also at the long end.
- Investors may want to consider inflation-linked bonds – including Treasury inflation-protected securities in the US and gilts in the UK. These should directly benefit from rising inflation expectations, since they are designed to help protect investors from inflation.
- Gold could also keep benefiting from easy monetary policy. There is a close historical connection between high gold prices and environments of low and falling real yields, because people often buy gold when they think other “safe” assets don't offer a better opportunity.