what will constitute 'safe' assets tomorrow?
As the Chinese and Eurozone economies gain traction, inflation pressures are building. Global bonds must come under further pressure. Yet, inflation is only half the story. Most of the collapse in bond yields in recent years was driven by capital flows: a hefty US$4 trillion-plus poured into US Treasuries, the US dollar and other ‘safe’ assets from ‘offshore’. Central Bank QE policies may have contributed, but they cannot explain the size of the flows. Our colleagues at CrossBorder Capital argued yesterday at the Global Independent Research Conference (held at the Royal School of Medicine, which is an excellent venue) that these flows are economically related, highly cyclical and already reversing. In February, China actually saw net capital inflows again. They threaten higher bond yields ahead by forcing depressed bond term premia back up and it is predominantly these ‘safe’ assets whose prices look out-of-line. In short, risk may come from where you least expect it. To understand this capital flow story, please click here.