The outlook for the bond market in the context of the rebound in global inflation expectations

The rise in commodity prices drove up inflation expectations. Since February 2021, with the accelerated global vaccination, economic recovery prospects are optimistic, overseas markets have opened a round of “re-inflation” transactions, and commodity prices have repeatedly hit new highs. As of March 15, West Texas Intermediate Crude Oil (WTI) has increased by more than 30% this year alone, and the price has slightly exceeded the level before the outbreak. The price of copper on the London Metal Exchange (LME) hit a record high in nearly eight years. Affected by this, the market’s concerns about rising inflation have intensified, triggering inflation expectations to rise all the way. The 10-year U.S. Treasury bond yield has again seen a steep upward trend, rising rapidly from below 1% in early January 2021 and breaking through 1.60%. The market’s inflation expectations continue to ferment with the upward trend of commodity prices, and are far higher than the level before the outbreak.

U.S. inflation expectations rise

As of March 15, 2021, inflation expectations in the United States have climbed to historical highs, but actual inflation data has not yet risen. In February 2021, the US Consumer Price Index (CPI) and core CPI are still below 2%. Based on historical data backtesting, inflation expectations are generally ahead of actual inflation indicators by 2 months. At the same time, combined with the supply and demand gap and base effect analysis, actual inflation data is expected to follow inflation expectations.

From the demand side, the US$1.9 trillion stimulus bill has come into effect. Substantial economic stimulus and higher household income levels brought about by direct subsidies will increase upward pressure on prices. With the increase in residents’ disposable income combined with the improvement of the epidemic situation and the recovery of demand, the US service industry is expected to accelerate the repair, which will also provide support for the recovery of core inflation.

From the supply side, the gap between supply and demand will continue to push up short-term price levels. Previously, the growth rate of the US retail industry was much higher than that of the industry, the recovery of production was slow, and the trend of inventory and prices diverged. In addition, the current progress of vaccination in various countries is uneven, and the recovery of production in some upstream resource countries has been slow, resulting in uncertainty in the subsequent supply speed. All of the above factors will increase upward pressure on inflation.

From the perspective of the base effect, the decline in crude oil prices to the level before the outbreak will also drive inflation data to rise sharply. The volatility of the U.S. CPI mainly comes from the energy sector, while the price of crude oil dominates the price of energy products. From March to May of 2020, WTI average price centers were 30.6 US dollars/barrel, 18.1 US dollars/barrel, and 28.6 US dollars/barrel. As of mid-March 2021, WTI oil prices had rebounded to 65 US dollars/barrel, even if oil prices were short-term The hub as a whole has stabilized or declined slightly, and it is expected that the year-on-year growth rate of oil prices from March to May in 2020 will also reach 100% to 200%.

It can be seen that the higher US CPI data will be a more certain event. Considering that the oil price center may fall in the second half of 2021, it is expected that the US CPI trend in 2021 will show a rapid upward trend in the first half of the year, a slow fall in the second half, and the center will maintain a relatively high level.

China faces imported inflation pressure

As my country’s epidemic situation and economic trends take the lead, the year-on-year growth rate of my country’s industrial producer price index (PPI) has rebounded from the low point of -3.7% in May 2020 to 1.7% in February 2021. The CPI is affected by the base figure. And pork prices fell back to a relatively low level. Considering that there is a positive correlation between the upward trend of my country’s inflation data and the upward trend of overseas commodity prices.

(1) There will be some convergence between the trend of China’s PPI and the trend of U.S. CPI

Through the analysis of historical data, it can be found that in the years (2006-2008, 2009-2011) when the price of commodities increased and imported inflationary pressures increased (2006-2008, 2009-2011), the synchronization between China’s PPI and the U.S. CPI was relatively strong. The reason is that the prices of commodities such as crude oil occupies a very important position in the measurement system of the US CPI and China’s PPI, and the direction of fluctuation is consistent. Therefore, in the current round of rising imported inflation pressure, the overall trend of China’s PPI may be similar to that of the US CPI, with greater upward pressure in the first half of the year.

(2) Price and demand will lead my country’s PPI to strengthen

From the perspective of prices, my country’s PPI statistics include two major categories: means of production and means of living. According to the data released by the National Bureau of Statistics, it can be estimated that the year-on-year increase in PPI data in recent years is mainly driven by the means of production. Among the main means of production, crude oil prices have the strongest correlation with PPI. Therefore, this round of rising prices of overseas commodities represented by crude oil prices will put upward pressure on the costs of Chinese manufacturing companies, which will then be passed on to the PPI. Looking forward to the next stage, the uncertainty of the US macro environment and external policies will decline, and the domestic manufacturing investment boom in 2021 will continue to improve, which will also drive upstream commodity prices. The logic of price increase and the stability of the number of orders will help the company’s profit restoration, thereby supporting commodity prices.

From a demand perspective, industrial manufactured products account for more than 90% of my country’s export products, and my country’s export situation is closely related to the demand for industrial products. Through calculations, it can be found that the export growth rate has a certain positive correlation with the PPI growth rate. In the context of the resonance of the overseas inventory cycle and the real estate cycle, the superimposed supply misalignment on the demand side will continue to support my country’s exports. The increase in vaccine coverage in the United States combined with the advancement of fiscal stimulus policies has further increased the certainty of the global economic recovery, and the demand for overseas replenishment of inventories is strong, which will also promote the continued strong growth of Chinese exports. Even if the recovery of overseas production capacity in the second half of the year will cause China’s export share to fall from its previous highs, under the positive influence of the global trade resonance in 2021, China’s exports will remain strong.

(3) my country’s CPI and PPI will diverge, and core CPI is expected to bottom out and move closer to PPI.

The decline in pork prices will hinder the overall strength of the CPI, which tends to be low and then high throughout the year. With the release of live pig production capacity, the year-on-year growth rate of the breeding sow stock has shown a steep upward trend since September 2019. Taking into account its leading role in pork prices and negative correlation characteristics, although the recent African swine fever epidemic has caused certain disturbances in pork prices, due to the overall capacity expansion, the pork price center will maintain an overall downward trend. Affected by the base, the low point of CPI may appear in the first quarter of 2021, and the subsequent CPI will gradually rise with the core CPI, and it is expected to reach the high point of the whole year in the fourth quarter. In addition, due to the CPI base period rotation1 in 2021, the weight of pork prices will be lowered. As pork prices decline, the market may overestimate the negative impact of the decline in pork prices this year on the CPI, and the CPI may be higher than expected in the second half of the year.

The core CPI can better represent the endogenous growth trend, and the subsequent recovery trend is clearer. Both core CPI and PPI can measure the results of effective demand expansion. According to historical data observations, there is no obvious deviation between the two in trends. In the current round of PPI upward cycle (from May 2020), since the recovery of production is faster than consumption after the outbreak, PPI has been in the upward channel since June 2020, but the core CPI is still showing a downward trend. A phased deviation. With the gradual restoration of consumer confidence, since October 2020, the rate of decline in the sub-item price of CPI rent has gradually narrowed, indicating that the job market has improved and the incomes of low- and middle-income groups have improved. It is expected that the core CPI year-on-year growth rate in the upward cycle of inflationary pressure may be possible. It has bottomed out, and the next step will follow PPI to enter the upstream channel.

Monetary policy response

The current market investors’ concerns about the upward trend of PPI are essentially concerns that rising inflation may trigger further tightening of monetary policy, which in turn will cause upward pressure on interest rates. Since 2006, China’s PPI has experienced four upward cycles2. By analyzing historical data, the author found that during the upward period of PPI, as imported inflation pressures appear, monetary policy will turn to a state of easy tightening and difficult loosening. However, in this round of PPI upward cycle, the operations of the central bank are different from the point of view of the timing of the monetary policy shift or the method of monetary policy regulation.

(1) Monetary policy is more forward-looking and precise

From a forward-looking perspective, in the previous rounds of PPI upward cycles, the timing of monetary policy tightening is generally at a time when PPI has risen or fundamentals have shown signs of overheating. The marginal shift in this round of monetary policy started as early as May 2020. At that time, the PPI year-on-year growth rate was at a low level of -3.7%. The overseas epidemic situation was escalating, the monetary policies of central banks continued to be loose, and my country’s economic data has not shown any significant improvement. . The central bank has proactively tightened its policy when the fundamentals begin to recover, so that the monetary policy can maintain its strength and leave plenty of room for follow-up operations. This is also conducive to compressing the upward space of the current round of PPI, and avoiding the premature and rapid rise of PPI, which will restrict the policy.

From the perspective of accuracy, the previous rounds of monetary policy control basically adopted strong signal measures such as raising the deposit reserve ratio and raising interest rates. However, because the global epidemic has not yet ended, the fundamental recovery is still unstable, and the monetary policy control is quantitative. , Price and policy tool selection to strengthen control. In terms of quantitative control, the central bank ended the use of RRR cut tools ahead of schedule, which not only avoids the over-fermentation of local asset bubbles caused by flooding, but also leaves enough room for subsequent policy operations. In terms of price control, the central bank did not take measures to raise interest rates, but used quantitative control to influence the price of funds, and gradually raised the operating center of the 7-day repo rate (DR007) of deposit institutions in the inter-bank market with interest rate bonds as pledged to around The neutral position of policy interest rate fluctuations. Since October 2020, the monthly average center of DR007 has basically been maintained at around 2.20%, reflecting the accuracy of regulation. In terms of monetary policy tools, the central bank uses diversified structural monetary policy tools to support liquidity, and through re-lending, rediscounting, and innovating monetary policy tools that directly reach the real economy, it provides targeted support to small, medium and micro enterprises that are more affected by the epidemic to prevent local Credit risk broke out.

(2) Monetary policy may be tightened later than expected

The author believes that in the current round of PPI upwards, monetary policy has been tightened forward-looking, and in the future, under the guidance of not “a sharp turn”, the timing of its clear tightening may be later than market concerns. It is less likely to increase interest rates and increase the deposit reserve ratio.

There are still three factors that limit the rapid tightening of monetary policy. First, unlike the supply-side structural reforms in 2016 that led to the increase in commodity prices such as steel and coal, this round of bulk commodity price increases is more related to the recovery of overseas demand, which makes my country’s imported inflationary pressures increase, and monetary policy adjustments should be used to counteract these increases. The effect of hedging is limited. Second, there is greater pressure to guard against credit risks in the post-epidemic era. The default event of state-owned enterprises in November 2020 had a major impact on the bond market. The maturity of credit bonds in the first and second quarters of 2021 will be 2.5 trillion yuan and 2.1 trillion yuan, respectively, and there will be greater pressure on debt repayment. Under the overall tone of “stable leverage” and “government leverage ratio should be reduced”, state-owned enterprises and tail urban investment platforms with weak credit status still have credit risk risks, which does not support a substantial tightening of monetary policy and affect liquidity Or increase financing costs. Third, my country’s economic recovery and employment expansion still need policy support. With the Fed and other overseas central banks still maintaining loose monetary policies, there is no need for further tightening of my country’s monetary policy.

Outlook for the next stage of the bond market

On the whole, the trend of PPI is consistent with the trend of bond market yield, and the main factor that affects the upward rhythm of bond yields is the turning point of monetary policy during the upward period of PPI. The turning point of this round of monetary policy is May 2020. Taking the 10-year treasury bond yield, for example, it will begin to rise sharply after bottoming out in April 2020. The risk has been released to a certain extent. In this round of PPI upward process The period of the fastest adjustment of bond yields has passed.

From a short-term perspective, there is a certain upside risk in the bond market yield in the second quarter, but strong allocation and low leverage will limit its upside space. In the medium and long term, the current market expects that interest rates in the second half of the year are expected to follow the marginal slowdown of the economy and begin to decline, but the author believes that there is a possibility that consensus expectations may fall. From a fundamental point of view, the continued pull of global trade resonance to my country’s exports and manufacturing investment is expected to support the economy in the second half of the year. With the rise in prices of resource products and industrial products in the upstream industry in the first half of the year, there is a possibility that the pressure of price increases will be transmitted to the midstream and downstream in the second half of the year. The core CPI driving the overall upward trend of CPI may suppress bond yields to a certain extent. From the perspective of policy and funding, the fiscal policy in 2021 is still relatively active, and the total issuance of interest rate bonds is basically the same as in 2020. Considering that local government bonds are not issued in advance in 2021, it is expected that the overall supply pressure in the third and fourth quarters will not be small. In the second half of the year, the allocation of institutions may not be as abundant as in the first half of the year, and the central bank may not increase its liquidity investment at some points, which will have a phased impact on the bond market. On the whole, bond yields in the second half of the year may not fall as expected by the market, and there is a high probability that they will maintain a range-bound pattern.

Note:

1. In accordance with the regulations of the statistical system, my country’s CPI statistics use the year of “5” and “0” as the base period, and select a basket of goods and services in the base year and remain unchanged for five years, in order to take into account the continuous comparability of the index and the changes in consumption structure Timely response. From 2021 to 2025, the National Bureau of Statistics will compile and release the CPI based on 2020.

2. The four upward cycles are from April 2006 to August 2008, July 2009 to July 2011, December 2015 to March 2017, and May 2020 to present.