Has the Federal Reserve finally burst the junk bond bubble? Perhaps, but then why is oil price inflation absent, yes oil has gone up we know but just wait.
Junk bonds took a pounding last week as investors fled the asset class due to rising rates and concerns about the passing of the Trump administration’s proposed tax changes.
Reflecting the sell-off, investors pulled $1.3 billion from global exchange-traded funds that track high-yield bonds during the week according to Bloomberg. The news outlet notes that investors have been pulling back from the asset class thanks to concerns that they “won’t be compensated for the risks of investing in bonds of companies with relatively fragile balance sheets if political risks rise or inflation accelerates.”
No Oil Price Inflation
Inflation is now back on the agenda for most economists. Economic growth and a strong jobs market are helping to push up wage growth, meanwhile, a weak US dollar and rising commodity prices are only pouring fuel on the fire. Tensions in the Middle East pushed crude prices to multi-year highs last week, which will have a knock-on effect on consumer prices.
That being said, the Treasury market does not seem to be pricing in much in the way of inflation. The real yields of TIPS -- which reflect expectations of the future real stance of Fed policy -- have barely budged since 21st June that's despite a near 36% increase in the price of WTI.
According to Capital Economics, this lackluster market reaction implies that the recent rise in oil prices is "likely to be reversed in due course," that's assuming hostilities between Saudi Arabia and Iran are avoided.
Additionally, CapEcon's John Higgins believes that the current oil price rally will not "have a big bearing on US equities either." Even though the rally has boosted the share prices of firms in the energy sector, "it has only slightly outperformed the broader market."
Even though CapEcon doesn't believe higher oil prices will have much bearing on inflation, Higgins and team believe the Fed will be forced to tighten faster than expected next year as wage growth picks up. Specifically, the team writes "the trigger for tighter-than-expected policy will be a pick-up in core inflation, as a shrinking pool of labor drives up wages."