Page 5 - Economic Update - June 2021

ECONOMICS

We then rolled from that straight into one of the
largest and fastest increases in government bond
yields seen in decades. It’s worth pausing to
note (and impress) that whilst rising bond yields
mean higher income returns in the future, it can
also mean large capital losses given a bond has

also worth noting that the bond’s coupon (what the
bond issuer promises to pay) is not the same as
the bond’s yield, with the yield calculated as the
coupon divided by the prevailing market price for
the bond. Whilst bond yields were likely to rise
over the course of this year due to a combination
unfounded), improving economic outlook, and

President Biden’s US$2 trillion package along with
the mention of more to come and some better than
expected economic data, was all that was needed

bond yields to the levels seen prior to Covid
beginning. In contrast, developed economy central
banks like the US, Europe, Japan, and Australia
loose policy stance (ie. rates at or near zero plus Looking forward
money printing) would be in place for some time
to come (ie. at least for the next 2 years, but likely It’s fair to say we’re at a juncture of sorts in terms
3 years). The result was a more than 4% fall in
Australian government bond returns in the quarter. with the US doing its best to stoke (or poke) the

In contrast, equity markets looked straight through

blind eye to their all-important nearest relative, central banks will act in the future – ie. either as a
and powering through any obstacle that could handbrake or as fuel for asset price growth. We’ll
be thrown at it. Not totally surprising given the know more on this front in the months to come,
quantum of both central bank and government something we will be watching critically, because

addition to vaccine optimism. But, and a very big
BUT at that, the bond market is largely used as
a valuation and pricing mechanism for the equity
market. That is, if bond yields are higher, either (including safety), vaccine distribution, and vaccine
equity earnings must rise to account for the price, take-up, as this then dictates the pace of country
or the price must fall to account for the higher bond re-opening and hence the pace of the economic
yields. Given the strong returns from equities, with
global listed property and infrastructure joining the improvement in corporate earnings and balance
party, it’s fair to say investors are currently betting sheets, whilst a slower pace than currently expected
that earnings will rise to justify the rising equity could result in earnings disappointment and
prices. Time will tell. stressed balance sheets which can then precipitate
a market correction. A watchful eye on both data
and corporate earnings updates will be key.

Chris Lioutas