Bond yields, inflation and George Soros

The US yields are up. The 10-year benchmark bond yield is trading at 1.38 which is its highest level in a year. The 30-year treasury yield is trading at around 2.18 which is a 100 basis points rise from its lifetime lows of 1.20 as seen last July. The Fed funds futures are also indicating that there are some bets in place that indicate that policy might begin to rise in mid to end 2022. The Fed chief on the other hand has promised repetitively that he doesn’t see the policy rates rising in the near future. As long as the economy looks fragile and the virus looks threatening, the support from Fed both in terms of bond purchases and low rates would continue. Markets obviously reinterpret the definition of a “near future” through changing the bond yields across the term.

Now the reader can have a genuine query about the market nervousness regarding inflation even when the current inflation readings have been low.  The January CPI print in the US was 1.4% and the average inflation targeting regime put out last year had confirmed that inflation will be allowed to run above 2% to compensate for the time spent underperforming the target. But apart from the actual inflation number there is an interesting concept called inflation expectations also. This essentially measures what you expect of inflation going forward. In his 1987 book The Alchemy of Finance, famous investor George Soros introduces us to a concept called reflexivity. Soros essentially states that observation of economy leads to ideas that change behaviour which in turn changes the economy itself. Now as per Soros the concept is visible in many forms, one example which he gives is about the stock of a particular company. Let’s say the company is in a bad shape (internally) but due to some extraneous reasons the stock starts doing well. The up move in the stock then reflects in the creditors allowing less onerous conditions on debt repayment. This results in the lowering of cost of borrowing for the company which improves its bottom line and eventually it comes back to good health.

Now lets the put the idea of reflexivity in the context of inflation and its expectations. Once the expectations that the inflation is going to rise in future takes ground then the public actions start evolving. Many purchases which could have been delayed will be preponed. This in turn will raise the demand and prices will rise, which in turn is nothing but the inflation. Hence the central banks around the world are very cautious about the inflation expectations and frequently run surveys to gauge the change in mood. We are sure in the coming days as the inflation narrative takes hold, we will hear about inflation expectations also frequently.

In the market roundup, equity markets like Hang Seng and Nikkei are trading in green. The Dollar Index has been trading mostly unchanged around the 90.30 levels. The Pound Sterling has broken an important level in 1.40 against the Dollar. The quick vaccine rollout and an impending announcement regarding the lifting of lockdown in Britain has resulted in positivity around the Pound. But interestingly the constant strengthening will hardly be reason for cheer for UK policy makers as it impacts the export competitiveness negatively. The Indian Rupee is trading around 72.50 levels whereas the benchmark 10-year bond yield is trading at 6.19 today in comparison to a 6.13 close on Thursday.