There are many crosswinds impacting on the direction of global sovereign bond yields. Persistent services inflation in the US and a very tight labour market (initial claims have fallen back to 222k) constitute upside risks. Severe weather (droughts) is pushing food prices higher globally once again. The Adobe Digital Price Index showed a 14.1% y/y surge in online grocery prices in August. Geopolitical risks are inflationary too. The threat of Russian retaliation to an EU cap on the price of Russian gas remains severe.
However, the disinflationary forces emanating from China may still turn out to be the overriding factor for global inflation dynamics over the next year. Shipping rates are tumbling, and goods prices are normalising. The twin ‘crises’ in Chinese property and Eurozone energy are sapping global demand. The risks are finely balanced, but US 10-year Treasury yields may be close to peaking for now. This may take some momentum out of the steep ascent in the dollar and may provide a floor for the S&P 500 too.
There remain country specific risks, however: Gilts and JGBs could underperform US Treasuries, whilst Chinese government bonds may outperform.
This is the short-term outlook. Longer-term, the direction of travel is less clear, and in fact the term premia on sovereign bond yields could rise. Decoupling between China and the US is clearly inflationary, as is the huge investment required for net zero. The response to the pandemic has arguably raised expectations regarding the role of government in future crises, but at some point, bond markets may balk at the lack of control over spending and the terrible long term fiscal outlook for many countries, including Japan.
Budget requests for the next fiscal year in Japan have topped Y110tr for the second straight year, according to Reuters. The Ministry of Defense has requested a rise in spending to record levels.
