While bond yields recovered from a severe deflationary scare, the degree ofreflation and steepening of the yield curve has been much less pronouncedthan in previous reflationary episodes (such as ‘09-10 or ‘13). As discussed(here), the degree of recent deflation scare and subsequent reflation wasexaggerated by the commodity price roundtrips. However, on a longer-termbasis, bond yields remain in a steeply declining channel. This applies not onlyto the US but most other jurisdictions.
At the same time, the US$ continues to be aggressively bid. Although beinglong US$ and short � and ￥ are clearly over-crowded trades and resilience ofweaker commodity-driven currencies (such as IDR), suggest that the US$could be vulnerable to a potentially significant pullback, supply of US$remains exceptionally low (here) whilst demand is high, implying continuingstresses in the basic ‘plumbing’ of the global liquidity system. Lack of US$ isdeflationary, and most of the US administration suggested policies (fromdeglobalization and repatriation of US corporate cash held overseas to eitherexpelling or slowing down flow of migrants) tends to be US$ supply negative.
Although global bond markets no longer factor-in deflationary outcomes,neither do they assume any meaningful reflation. Indeed, if one looks at basispoint swap rates, there is no evidence that investors believe that supply ofUS$ is likely to improve. Given that the US$ underpins ~80% of global tradeand ~75% of cross-border finance, any further tightening of US$ flow wouldcontract global liquidity and end reflation and global leveraging. Essentially,the global economy needs the US economy to overheat and deliver muchlarger (rather than smaller) deficits and it needs for the conventional andshadow banking sector to much more aggressively multiply US$ liquidity. Atthis stage, there is no evidence that on a global basis this is occurring.
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