Summary of key points
- Three weeks ago, we said that the more likely catalysts for a short term market sell-off included policy maker mistakes, such as too much monetary tightening in China or too rapid an increase in interest rates by the Federal Reserve in the USA, and that the early warning signs of these sorts of catalysts will be easier to discern and act on than geopolitical shocks. In our view that remains the case, but a significant portion of the US equity market has anticipated a policy maker rise in US interest rates in response to a single data report.
- Three weeks ago, we said that the more likely catalysts for a short term market sell-off included policy maker mistakes, such as too much monetary tightening in China or too rapid an increase in interest rates by the Federal Reserve in the USA, and that the early warning signs of these sorts of catalysts will be easier to discern and act on than geopolitical shocks. In our view that remains the case, but a significant portion of the US equity market has anticipated a policy maker rise in US interest rates in response to a single data report.
- Although it was a modest uptick in wages inflation and is subject to revision, it was enough to tip the scale in favour of selling equities and buying bonds. The slide was probably made worse by program trading that added to the sales momentum.
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The continuing reality is that worldwide inflation and short-term interest rates remain lower than usual and are likely to do so for the next few years and long-term bond yields are still very low, although they have started to move up, as we expected.
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The rise in the US ten-year Treasury bond yield has accelerated, moving up over 0.4% p.a. since the end of December. The most recent budget proposal from the Trump Administration adds significantly to what was already an increased fiscal deficit, extending over the next ten years. This will add a lot to the need of the US treasury to sell more bonds over that period. We therefore expect the rise in long term bond yields to continue, but based on historical evidence, it is not expected to affect equity prices adversely in any lasting way until it reaches 4% p.a. This will probably take several years but it could conceivably happen within the next two years. We need to continually monitor the US ten-year Treasury bond yield- the world price of long term money.