Andrew Miller: Don't be bullied by bonds

Last week, chairman of the Federal Reserve (Fed), Ben Bernanke bent the knee to the bond vigilantes

Last week, chairman of the Federal Reserve (Fed), Ben Bernanke bent the knee to the bond vigilantes.

The 10-year treasury yield had risen on Monday to 2.7%, some 1.3% above last summer’s low. The bulk of the move happened after April in expectation that the Fed would announce a “tapering” of quantitative easing, kicking off the “great normalisation” of monetary policy. On June 19, it did just this. And as we warned then, pundits began to question whether that process would itself undermine the economy.

Hence, this week, the chairman sought to reassure bond investors that the process will be slow and gradual. The 10-year yield fell back to 2.5%. The dollar was also boosted.

Against a backdrop of improving market conditions, risk appetite and confidence is likely to rise among investors, consumers and companies. They, in turn, veer towards more risky investments and spend more of their incomes.

Reduced demand for cash and bond investments – along with lower saving ratios – combine to squeeze rates and yields higher. Central banks preside over and rubber-stamp these changes but are rarely the prime movers of them.

In the meantime, almost unnoticed, the US government deficit has been falling quickly. The decline is dramatic because it appears to have coincided with relatively modest economic growth. The point is not that a smaller deficit will materially reduce any further rise in bond yields – it won’t. It is, however, loosening one of the potential medium-term constraints on growth, namely the threat of a significant fiscal tightening.

As a result, we continue to strongly prefer developed stocks to bonds in balanced portfolios, and prefer using any rallies in the latter as an opportunity to reduce holdings in the more expensive fixed income segments. Stocks are best placed to benefit from ongoing growth, and remain inexpensive. Indeed, if we’re right about there being further loosening of monetary policy on the horizon, the assets that have been boosted excessively by quantitative easing and low interest rates are most vulnerable; gold is the most obvious example. Some other metal prices are also exposed to excess supply. Our Tactical Allocation Committee this week moved to reduce our exposure to commodities, and raised our position in cash to overweight.


David Whetstone
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Graeme Whitfield
Business Editor
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