When tailwinds turn: Headwinds to hit in 2022

Bond markets performed strongly over the month of November, regaining ground after the large moves experienced in October. Markets continue to focus on the removal of Central Bank accommodation - reducing or ceasing QE programs and the pathway for rate hikes into 2022. 

The reaction of bond markets remains different by tenor. 

Short maturity dated bonds are rising in yield/falling in price in anticipation of rate hikes, whilst longer-dated maturity bonds are falling in yield/rising in price on the assumption that such moves will kill the economic recovery. 

Earlier this month, two year bonds rose in yield by 10 basis points (falling in price), whilst the 10 year bond fell in yield by 16 basis points (rising in price). Such a move has only happened once in the last 39 years, being November 2008 as the US Federal Reserve started its QE program.

The removal of monetary policy through both the reduction of QE and then into the raising of short-term interest rates should generate a natural peak of excess liquidity in markets. 

This is also occurring at a time when fiscal spending will be curtailed significantly into 2022, suggesting that the easiest money has been made in the post-Covid cycle for many asset classes as tailwinds turn into headwinds. 

Despite growth expectations remaining fairly healthy into 2022, some markets with strong predictive abilities are not playing along.

Regarding Omicron, hopefully supply chains can fend off this possible interruption and continue to normalise, albeit slowly, as we have started to see a drop in demand for physical goods (70% plus of the economy in Australia is services) and associated costs such as energy and heavy reliance on transport and delivery networks etc. 

Omicron certainly has the potential to reverse these small improvements in supply lines and will require close monitoring to calibrate politicians' actions, which will ultimately have ramifications for near term inflation and therefore Central Bank responses. 

We believe 2022 will see a reduction in both monetary and fiscal support for markets and as a result we envisage increased financial asset volatility.

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