Monetary tightening could awaken bond bears

Business Insider | 12/21/2017 | Kathy Jones, Charles Schwab
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Past the peak of central bank stimulus: Led by the Federal Reserve, major central banks are poised to reduce the amount of monetary stimulus flowing to the global economy. Deflation fears are easing, with interest rates slowly moving out of negative territory in Europe and Japan, a trend we expect to continue in 2018.

Potential inflation surprise: Stronger economic growth, a tight labor market and the prospect of tax cuts could mean that inflation in the U.S. hits or exceeds the Federal Reserve’s 2% target in 2018.

Markets - Rates - Yield - Curve - Credit

Markets appear complacent: With rates low, a flattening yield curve and tight credit spreads, fixed income markets aren’t priced for higher inflation or volatility.

2018 could be the year that bond bears finally awaken from their long slumber, sending 10-year Treasury bond yields above the three-year high of 2.6%. Economic growth is picking up both globally and domestically and fiscal policy is becoming more expansive.

Era - Money - End - Federal - Reserve

Most importantly, the era of extremely easy money is coming to an end. The Federal Reserve is tightening monetary policy through rate hikes and balance sheet reduction. The European Central Bank (ECB) is planning to gradually reduce its bond buying program. Even the Bank of Japan (BOJ) is seeing some success with positive inflation while focusing on keeping 10-year bond yields at zero or above. As the easy-money era gradually recedes, we see more upside risk in yields than downside.

Most segments of the fixed income markets appear expensive relative to long-term average valuations. Yields in the...
(Excerpt) Read more at: Business Insider
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