Bond markets set for a taste of the 60s as inflation picks up

Mon Jan 30, 2017 11:17am EST
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By Dhara Ranasinghe

LONDON (Reuters) - Inflation has a habit of creeping up on you. Just ask historians.

From rates below zero less than a year ago, inflation across the developed world has risen in recent months toward central bank targets, largely driven by a rising oil price.

And if history is any guide, bond markets had better beware.

Paul Schmelzing, a visiting scholar at the Bank of England from Harvard University, has studied 800 years of bond markets history and says the most relevant parallel with today's environment is with the late 1960s under U.S. President Richard Nixon.

The United States was emerging from a prolonged period of low inflation, the jobs market was tightening and a new pro-business president had raised expectations of fiscal expansion. It was a bruising time for bond investors.

U.S. bonds lost 36 percent in real price terms between 1965 and 1970, while annual consumer price inflation more than tripled in the period, to 5.9 percent from 1.6 percent.

As the world's biggest bond market, what happens to U.S. Treasuries usually sets the tone for bonds across the world.

The specter of what Schmelzing describes as an "inflation reversal" could be the final nail in the coffin of a 36-year bull run in government bonds that has been underpinned by years of low growth and subdued inflationary pressures.   Continued...

A shopping trolley is pushed around a supermarket in London, Britain, May 19, 2015.   REUTERS/Stefan Wermuth/File Photo