The policy failures came, almost universally, from central bankers’ "premature celebration" of success.
Today’s talk of Table Mountain may be an honest reminder to investors that while central banks have been reasonably successful at bringing inflation numbers back to target, squeezing that last 2 per cent of embedded service sector inflation out of the system will be a long job.
By the end of 2025 we expect the UK to be 2.7 per cent and the US at 2.5 per cent. Nevertheless, that progress is enough to potentially underpin bond yields.
With yields sitting at around 6 per cent for UK corporates and 5 per cent for US treasuries, the opportunity to build a well-priced bond portfolio is presenting itself.
Could higher oil prices re-energise inflation?
The second challenge for bond markets is the risk of a renewed inflation shock triggered by rising energy prices. Having been remarkably subdued for most of the past decade, in part because of surging US domestic production and a broad absence in military conflict, the outbreak of war in the Middle East has of course complicated matters.
To begin with, an expected increase in defence spending around the globe will only add pressure to already stretched defence budgets.
Multi-year commitments to Nato spending in the face of a potential stalemate in the Ukraine will now be compounded by military aid and equipment commitments to Israel and potentially others in the region – all will require substantial extra spending.
Then there is the risk to crude oil (WTI) prices. Surprisingly, these are little changed on the year, and have only risen by 4 per cent since the Israeli-Hamas conflict began on October 7.
In part this is because several non-Opec+ nations, including Brazil, Guyana and the US, are poised to ramp up production while supply from renewables is inexorably climbing. In addition, history shows that if today’s tragic conflict does remain essentially localised (albeit a big if), then the effect on energy prices tends to be modest.
But while markets remain stable for the meantime, the risks are clear. A surge in oil prices in the face of a wider conflict could turn today’s global slowdown into recession, while at the same time triggering a second inflation shock. Stagflation would be the ultimate risk and ultimately a further round of rate rises.
Unions demand a catch-up in real wages
A third challenge for bond investors has been the labour unions’ determination to recover the multi-year losses in real wages suffered by their members. In the UK we are still facing substantial wage demands from the health and rail sectors.
In the US, the United Auto Workers union is, for the first time, striking at all of the three biggest US producers (GM, Ford and Stellantis).
As we write this, it looks as though the union is close to settling after six weeks of strikes, but the settlement is still substantial with a 25 per cent rise and other benefits, which will add, for example, another $900 (£722) to the price of every Ford built.
