Home >Opinion >Columns >The bond market’s non-taper tantrum is odd but explainable

On 10 February, Jay Powell, chairperson of the US Federal Reserve, gave a speech on the importance of keeping monetary policy accommodative to ensure that America’s reserve pool of labour is fully utilized. He promised that monetary policy in the US will keep in mind the slow labour-market recovery that took place after the global financial crisis (GFC). Therefore, the Fed will not make the mistake of trying to prematurely taper its purchases of Treasury and agency-backed securities that it did back in 2013. In other words, there would be no ‘taper tantrum’ this time.

The global bond market, however, appears to have thrown a tantrum because of the Fed’s non-taper pledge. In the 10 days since Powell delivered his speech, the yield on the 10-year US Treasury Note rose by around 20 basis points. Is the bond market, then, worried about a resurgence of inflation?

Prices of food commodities, industrial metals and even crude oil are on the rise. A big fiscal stimulus is on its way in America. There is pressure on the UK’s chancellor of the exchequer to emulate America. The US fiscal stimulus in response to covid will be nearly 25% of its gross domestic product. In the meantime, the Conference Board reports that chief executive confidence is at a 17-year high. Unit labour costs in the non-farm business sector are rising at an annual rate of 5.6%, matching its fastest pace in nearly four decades. Superficially, it looks like both reflation and inflation are in the American air. Why, even Europe’s rate of headline inflation perked up in January.

It is possible that economic growth will rebound in the developed world from the second quarter of 2021 or in the second half of the year. That will be the base effect 2020’s contraction. But, years of low interest rates and liquidity provision have added $70 trillion to global debt levels since the taper tantrum of 2013. Debt is a deadweight. As though to prove the point, not only is the number of zombie companies in America much higher than before, but they carry $2 trillion of debt. To be sure, not all zombie companies—entities that do not earn enough to cover even their interest payments—remain zombies. Some recover. But, capital locked up in most of them is deadwood. In other words, there is a good chance that reflation will be stillborn.

What about inflation? Well, rising commodity prices, increasing unit labour costs, fiscal expansion and its accommodation by central banks appear to be the perfect combination for the return of inflation. That is one of the reasons behind the sharp rise in the yield on the 10-year bond from a low of 0.54% in March, and again 0.56% in August 2020, to 1.38%. To put these numbers in perspective, the 10-year Treasury yielded nearly 2% as the year 2019 wound down. No one was talking of a resurgence in inflation then. The price of West Texas crude oil at the beginning of 2020 was slightly higher than it is today. In other words, not only is the recovery in input prices merely restoring the levels that prevailed a year earlier, it is also true that the run-up in their prices needs to be much longer and larger for them to affect the overall inflation rate.

In the developed world, labour cost has been a critical factor in inflation outcomes. Does the rise in the non-farm business sector unit labour cost presage an inexorable rise in the inflation rate? Well, the relationship between this indicator and the consumer price index (or any of its variants such as PCE, or Personal Consumption Expenditures, headline or PCE core inflation rate) had broken down since the 1980s. The rise in unit labour cost is perhaps a better indicator of a collapse in output in certain sectors rather than that of an increase in wage costs. Moreover, the Federal Reserve Bank of San Francisco in its Economic Letter published in August 2020 warned us to beware of averages. The letter called it ‘the illusion of wage growth’. Average wages had increased because establishments—especially smaller ones—laid off their lowest paid workers first. Overall wage costs declined, but the average went up. The authors show that wages for continuously employed workers rose only by 2.4% year-on-year in the second quarter of 2020, whereas median weekly earnings were higher by 8 percentage points. Proving this point are the total compensation costs measured by the employment cost index. At 2.5% in the fourth quarter of 2020, they are well below the recent peak of 2.9% reached in the fourth quarter of 2018. It is no surprise, therefore, that the PCE core inflation rate was hovering around 1.5% in December.

In short, while the fear of inflation is not ill-founded, it is premature. What we have in plenty already is asset price inflation. That train had left the station long ago. Central banks waved it off and are still waving it past. Once that train eventually stops, the effect will be deflation. Central banks will probably then go the full Monty on monetary policy, and then we will have inflation.

That looks like a story for the next American president. It may well be the last act of the post-Bretton Woods global monetary regime. For now, the asset-price roller-coaster should prepare for a big plunge to come.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views.

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