Who buys bonds the Fed no longer wants?

The blows to the bond market will continue until morale improves. It has not been fun to invest in fixed-income securities in recent months. For example, the three-year yield on US Treasuries has increased fivefold since the beginning of October; the ascent shows little sign of slowing down. If bond traders are correct in their forecast that inflation has become endemic soon rather than temporarily, the stock market had better be careful.

Central bankers everywhere are feeling the pressure to emulate Paul Volcker, the Federal Reserve chairman who tackled famous inflation by raising interest rates in the early 1980s. “Cutting down inflation is paramount,” said the usually calm Fed Governor Lael Brainard earlier this week. But as British hedge fund manager Crispin Odey, who has made huge profits this year betting on bonds, wrote in a letter to clients last month: “Everyone knows the West is bankrupt somewhere around 3% interest rates, so the battle is how a 0.5% interest rate could slow inflation, which may be headed for 10%.”

The speed of change in the inflation outlook was outlined earlier this week in a speech by Agustin Carstens, chief executive of the Bank for International Settlements. Carstens suggested that a “paradigm shift” might be needed, as limiting consumer price increases is inconsistent with the growth-promoting monetary and fiscal policies pursued by central banks and governments in recent years:

We may be on the cusp of a new era of inflation. The forces behind high inflation may persist for some time. New pressures are emerging, not least from labor markets, as workers attempt to make up for the inflationary cuts in real income. And the structural factors that have kept inflation low in recent decades may diminish as globalization recedes.

Former Fed policymaker Bill Dudley recently warned in a Bloomberg Opinion column that to be “effective” at calming inflation, the central bank will have to “inflict more losses on stock and bond investors than it has hitherto.” .” An environment where interest rates are rising rapidly could create an ugly mess in stocks that can be hard to stop. Add to that the fact that economists surveyed by Bloomberg estimate the probability of a recession in the US at 20% in the next 12 months, and the stock market seems increasingly vulnerable to a sell-off.

Too much money sloshing around the system for too long has undoubtedly contributed to the inflationary mess, propelled by a Fed balance sheet that has risen to $9 trillion. The central bank, which only stopped replenishing its bond stack last month, is now looking to make a sharp turnaround. On Wednesday, it indicated in the minutes of its most recent meeting that it is considering both selling bonds worth $95 billion a month and a half-point hike in interest rates. And at the European Central Bank’s policy meeting last month, “a large number of members believed that the current high level of inflation and its ongoing nature required immediate further steps towards normalization of monetary policy,” the minutes released Thursday showed. published.

It will be difficult to rid the financial markets of monetary stimulus. Who buys the bonds the Fed no longer wants? As much as the purported benefits of quantitative easing are opposed to quantification, it is impossible to calculate the consequences of the exit plan in advance.

The S&P 500 index is down just 6% this year, which feels wrong if Corporate America decides to hold off on spending and prepare for a coming economic storm. Fed Chair Jerome Powell has emphasized the need for an agile approach to policymaking. The fancy footwork needed to land a soft economic landing and avoid a recession while curbing inflation requires the agility of Fred Astaire and Ginger Rogers. With central bankers unlikely to match the prowess of the female half of the dancing duo at executing the strides backwards and in high heels, stumbling seems likely.

More from Bloomberg Opinion:

• If Stocks Don’t Fall, The Fed Should Force Them: Bill Dudley

• An inflation update and how Brainard is doing well: John Authers

• All that is stopping a full-blown food crisis? Rice: Javier Blas

This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist on European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

Mark Gilbert is a Bloomberg Opinion columnist on wealth management. Before that, he was the London bureau chief for Bloomberg News. He is also the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

More stories like this are available at bloomberg.com/opinion

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