Yields, commodities whisper of reflation promise

By Wayne Cole

SYDNEY (Reuters) – A sudden sell-off in safe-haven bonds, and an equally rapid revival in resource prices, could herald the end of the dog days of deflation and a return to the more reflationary world of old.

The epicenter of the dramatic slide in bond prices has been the euro zone, where yields on 10-year German paper tripled to 0.517 percent in just four sessions, erasing all the price gains made this year.

A positive spin on this would be that the European Central Bank’s massively expanded campaign of asset-buying is working far more quickly than even optimists dared hope.

“There has been a profound easing in financial conditions over the past six months – a potent dose of stimulus,” said Christel Aranda-Hassel, a research analyst at Credit Suisse.

“There are clear upside risks to euro area growth this year and next. In that respect, the economy looks ever more inconsistent with zero and falling bond yields.”

The fact other bond markets have followed suit suggests investors globally might be sighting economic recovery and inflation on the horizon, even if the flow of actual data has been mixed at best.

Growth numbers have revealed a sharp loss of momentum in the U.S. and Chinese economies in the first quarter, while business surveys showed Asia remaining sluggish in the coming months. But data last week showed the euro zone had emerged from deflation, the U.S. service sector is expanding nicely and wage inflation is picking up in the United States.

Yields on 10-year Treasuries touched a two-month top at 2.20 percent on Tuesday, having climbed from 1.92 percent in little more than a week.

Yields in Australia, Canada and Britain all hit their highest in at least four months, with British bonds bearing the added burden of political uncertainty ahead of a general election on Thursday.

While global turning points are notoriously hard to call, commodities have also been acting that way in recent days.

Oil and copper prices have sped to their highest for the year so far, while zinc reached ground not trod in eight months.

Brent crude has climbed 50 percent from its January trough to reach $68.24 a barrel, with U.S. crude not far behind at $61.34.

A chart of the jump in bund yields look eerily similar to that for copper, hinting at some correlation if not causation. (http://link.reuters.com/few64w)

TERM RISK TANTRUM

However, a far less benign explanation for the back-up in bond yields might be the simple pressure of positioning – that the rush for returns at ever-longer maturities drove yields so low that buyers went on strike.

This is a theory favored by RBS’s head of treasury strategy, William O’Donell, who calls it a “Term Risk Tantrum”, referring to the premium investors demand for lending money out for years and years.

“In our opinion, this macro re-pricing is synonymous with the fraying/unwinding of many “crowded” trades across fixed income and risk markets.

“It looks like we are nearing the precipice of what could prove to be a sustained outright bearish correction.”

If the rise in yields is not a reflection of an improving economic background, then it may prove self-defeating by tightening financial conditions and snuffing out any recovery.

Key will be whether policymakers start publicly protesting at the sea change in bonds, as they have so often in recent years.

“It all reads like a global economy that is not sure if it is at a turning point or not – the long end of the yield curve says ‘yes’ but central banks still say ‘maybe’ at best,” wrote analysts at Rabobank in a note to clients.

(Additional reporting by Vidya Ranganathan in Singapore; Editing by Alex Richardson)

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