Global Inflation Expected To Pick Up; Possible 1994-Style Rout For Sovereign Bonds

That possible rout is not due to sovereign debt crises, but the need for central banks to raise interest rates to fight inflation. Already, some central banks are raising rates for that purpose. Others will have to join in too. The European Central Bank (ECB) is threatening to. Once the Federal Reserve and the ECB join in, there will likely be rate hikes all across the world. If so, then sovereign-debt securities will be in for a global squeeze like 1994's.

“There is a recipe for disruptive dynamics in markets if policy adjustments have to gather steam in a synchronized way,” said New York-based [Bruce] Kasman, a former official at the Federal Reserve Bank of New York who now oversees economic research at the second-largest U.S. bank by assets. Such a scenario could develop in 12 to 36 months and would “take a toll on risk assets. Bonds get killed,” he said....

Although he doubts developing countries are losing control of inflation, Jim O’Neill, the London-based chairman of Goldman Sachs Asset Management, says the yield on the 10-year U.S. Treasury note could “quickly” reach 5 percent if global growth is allowed to pick up faster than anticipated, forcing the Fed to start normalizing policy. The interest rate on the benchmark U.S. security was 3.49 percent on March 4....

“The biggest thing I worry about is a major sell-off in bonds like 1994,” said O’Neill, who helps to manage about $840 billion. “The ideal situation is the developed world comes back as the developing world slows, but what could happen is as the U.S. and others strengthen, they give the developing world another growth kick.”

The trouble is, central banks seem to be behind the inflation curve. (Veteran central-bank watchers won't be surprised.) There's some sign that inflation in mainland China is feeding on itself despite rate hikes by the People's Bank of China. One expert in the symposium said that central banks may let inflation run because of fears of financial instability.


As the fears engendered by '08 fade, it does look like the central banks have done it again - although they had help from too-optimistic sovereign debt markets. Real rates on global bonds are at about zero, providing further fuel for gold's climb.