Albert Edwards, strategist at Societe Generale, commented that of all the moves seen in the last few weeks, perhaps the one that surprised me the most was the dramatic rise in yields on inflation linked bonds, outdoing the rise in yields seen on conventional bonds. To be fair, the dramatic sell-off in bonds began right at the start of May when T-Note yields bottomed at 1.63 percent, well ahead of Bernanke’s speech last week.
The bloodbath in the bond markets has led some commentators to see this as the end of the long bull market. Indeed, a recent Bloomberg article headlines an impending “lost decade for bonds”.
This prompts notedly bearish Societe Generale strategist Albert Edwards to pose the question in his latest market commentary: “Is the Ice Age over?”
The “Ice Age,” a term Edwards uses to describe a series of economic cycles characterized by “lower lows and lower highs for nominal economic quantities,” driving a “re-rating of government bonds and the de-rating of equities – each recovery bringing a partial reversal to the process and each recessionary phase taking us to shocking new lows, both in bond yields and in equity multiples.
Societe Generale’s Economist Aneta Markowska has been spot on in her forecasts in recent months, including what Bernanke was going to say about tapering last week. But it is also notable that she describes the US economic data as merely “lukewarm” and not responsible for the run-up in yields prior to the speech. Instead she believes that the Fed had previously introduced uncertainty as to their intentions on tapering. But despite Bernanke having removed much of that uncertainly, the bond markets (and much else besides) certainly did not like what they heard. Indeed the bond rout occurred despite some commentators describing Bernanke’s speech as rather dovish in making clear very robust economic prerequisites for tapering. But amid the six-week sell-off ahead of last week’s speech, a considerable head of bearish steam had already built up – with it morphing into red mist and clouding clear vision, the “feral hogs” in the bond markets charged.
Albert Edwards Conclusion
Edwards doesn’t think we’ve escaped the Ice Age. Instead, he asserts that deflation risks remain high. He points to persistently low inflation, which the Fed has seemingly dismissed as transitory, and the crisis unfolding in emerging markets right now, which he says present a “good chance of a repeat of 1998 where a deflationary wave of manufactured goods washed up from Asia.”
The recent surge in bond yields was driven by a sharp rise in real yields, implying a sharply reduced outlook for inflation in the marketplace.
Edwards doesn’t see that as sustainable, and given his outlook for weaker economic data in the future, he doesn’t see any way the Fed will be able to ease off the QE pedal. And that will eventually force yields back down again. “Indeed, let’s put the recent bond sell-off into a longer term context. Bond yields at 2.5% still remain locked in a technically well-established bull trend that will not be broken until yields spike above 3.5 percent,” writes Edwards. “Who knows, the ‘feral hogs’ may have their grunting way but by that time, with that degree of monetary tightening we will undoubtedly be back in deep recession and yields will be back on their way down again.”