De Gaetano Andrea Analista indipendente BondWorld

BondWorld : The week of the ECB and US inflation

BondWorld : Persuasive as the song of the Sirens, central bankers have convinced investors that there is no danger.

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Andrea De Gaetano – Independent Analyst

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The miracle of galloping economic recovery accompanied by undying monetary stimulus will continue. The message has been echoed by the Fed and ECB, reinforced by the central bankers of the individual countries.

Following in the footsteps of the Fed and ECB, Ignazio Visco, governor of the Bank of Italy, reiterates the importance of maintaining long-term accommodative financing conditions, in order not to repeat the mistake of 2008-2009. This, despite the Bank of Italy’s forecast of a vigorous recovery in Italian GDP, above 4% in 2021-2022.

Last week, the FED, careful to take the first stick out, as in a game of Mikado, said it would start selling corporate bonds and fixed income funds. The news was snubbed by investors because corporate bond holdings represent a fraction of the Fed’s balance sheet compared to Treasury purchases. The stance remains accommodative.

U.S. employment data in May gave the Fed an assist, with one good figure and another not so good. Unemployment fell to 5.8%, from 6.1% in the previous month, better than expectations of 5.9%. 559,000 new employees, less than the 650,000 economists were expecting.

„Too much“ positive data would be a banana peel for central banks, busy serving up delicious courses of zero rates to markets, despite signs of a frothy economic recovery.


Other assist, data on US durable goods orders, down more than expected, cooled enthusiasm for data on the services sector which grew in May for the 12th consecutive month, Final Services PMI at 70.4%, with all 18 service industries up.

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Oil at the $70/barrel mark, skyrocketing U.S. housing prices, metals and commodities sprinting back the 10-year T-Note to the 1.60% yield area. Real yield still negative with an inflation rate at 4.2% in April (3% net of food and energy). The next data on U.S. inflation coming on Thursday, June 10, the same day of the ECB press conference, will be a special watch.

Europe, a bit behind the US, is catching up.

Markit PMI data on the service sector, at 57.1 in May, marks the third consecutive month of expansion and the best increase since February 2018. The increase in new orders has been such that companies have been struggling to manage them.

Confidence about future business prospects has improved to record levels since 2012.

This explains the jump in flash estimates of European inflation expected at 2% in May (0.9% excluding food and energy), driven by energy and services prices.

Despite the inflation jump, government bond yields remain in negative territory in Germany. Not even in Italy do they cover the cost of inflation.

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The combination of economic recovery and monetary stimuli is taken for granted by the markets, which present themselves with towering valuations at the upcoming ECB and FED meetings on June 10 and 16.

Christine Lagarde will open the dances with the ability of a tightrope walker in order not to disrupt the Brahminical calm that reigns on the markets.

Should there be some misstep, the markets will have a good opportunity to stop for a moment. If not, we would have a further stretch bordering on intoxication.

Either way, as long as short-term rates remain stuck at zero with a recovering economy, the picture will remain more favorable for equities than for bonds.

High Yields, the stars of the last year, protect better against inflation than other bonds. High inflation is accompanied by higher growth and riskier companies (which issue High Yield bonds) are more likely to survive in a high growth scenario.

On the other hand, when inflation rises too fast, investors start selling riskier bonds, waiting for central banks to raise rates, to move to higher rated bonds. For now, this phenomenon has begun to manifest itself in 10-year US T-Notes. Yields have fallen a bit, from 1.77% to the 1.60% mark.

Looking forward, we remain 50% invested while maintaining a 50% in cash.

As bond guru Bill Gross, co-founder of Pimco, pointed out, „The real kings and queens of bonds sit on the throne of the Federal Reserve. Cash has been junk for years, but it may be investors‘ only refuge.“

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