Government Bonds Rally As Reflation Trade Runs Out Of Road:

Last week the markets came down with a nasty bout of reality. It came as investors decided the whole idea of a new roaring ‘20s maybe wasn’t the nailed-on certainty they thought. The spread of the Delta variant, delays in new US infrastructure spending and a more hawkish US Federal Reserve have all served to dampen down growth and inflation expectations. Bonds are on the rise, and equities are struggling. So, the “reflation trade”, that has been all the rage, appears to be coming to an end. Low growth and low inflation have been endemic ever since the financial crisis more than a decade ago. That the missing ingredient needed to finally turn the reflation trend around was a global pandemic always seemed a bit unlikely.

The market is sending a clear signal to policy makers. Investors were at their most optimistic when they thought central banks were going to fund a multi-year spending binge without overly worrying about inflation. While there is little appetite for that policy now, hence the correction, the government spending genie might be out of the bottle. In the longer term, temptation to spend freshly printed money might prove too much.

Government Bond Yields Tumble As Inflation Fears Recede

Away from immediate talks of reflation, the biggest move in markets last week was the fall in government bond yields. An increase in investor demand accelerated the steady decline in government bond yields seen in recent months. The fall in yields has been most dramatic in UK gilts. But, US Treasuries and the bonds of other developed countries have followed the same trend. The effects were also felt in equity markets. It comes as high growth tech stocks rallied at the expense of value stocks.

The decline in yields has been most noticeable in longer dated bonds. This suggests that markets have gradually accepted that inflation will be transitory and interest rates will remain at very low levels. Data released last week showed that European retail sales fell in the second quarter. Meanwhile, in the UK consumer credit and consumer spending have been falling since April. This has gone some way to ease concerns that lockdown would release a huge amount of pent-up consumer demand. The increase in coronavirus infections also saw expectations of further rapid economic growth reduced.

Regulatory Concerns Weigh On Some Tech Stocks

Chinese ride-hailing service Didi Chuxing saw its value drop by a third last week. China’s cyber security regulator ordered its app to be taken down due to suspected violation of data rules. So, the drop came as little surprise. The previous week the company raised more than $4bn during its New York IPO. But, the launch of the investigation saw its shares plunge. So, the broad decline in US-listed Chinese stocks was perhaps inevitable.

Chinese technology stocks have seen increasing regulatory intervention in recent months. Companies listed outside of China and Hong Kong received particularly close attention, as China exerted its authority over these giant companies. Chinese tech stocks have recently underperformed. This has been partly due to regulatory interference. Also, some tech companies have retreated from stock market listings as they become more conscious of the regulatory risks involved. Keep, a fitness app backed by Softbank and Tencent, recently cancelled its plans for an IPO. And, remember, last year saw the IPO of Ant Financial cancelled at the last minute.

 

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