Markets

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

From Washington to Tokyo, the message is loud and clear. Unfortunately, a big swathe of investors aren't listening.

Central banks want steeper yield curves. They want inflation, and inflation is coming. Expect yields on long-term government bonds to rise relative to their shorter counterparts.

The catalyst is likely to be a Federal Reserve rate rise in December. The Street has spotted it, and so has the relatively smart money.

Morgan Stanley and Goldman Sachs both expect 10-year rates to rise. Investors like Pimco, M&G and Legal & General have been reducing their duration -- cutting their holdings of longer-dated bonds. And Goldman has warned that duration exposure is at an all-time high.

Volatility doesn't seem to have got the memo -- it's now around the lowest in almost two years.

Eerily Calm
Volatility in Treasury options is nowhere, a sign that investors haven't been scrambling to reposition themselves before the yield curve steepens.
Source: Bank of America Merrill Lynch

And neither has the yield curve. It hasn't shifted in the way you'd expect, given the clear signals from policy makers and the public views of so many investors.

Look at the difference in yield between the 10 year U.S. Treasury and the two-year. It's hardly moved -- it's been stuck in the same range for months.

Far Too Flat
The yield curve has hardly budged over the last three months, despite all the signs of faster inflation and central banks' willingness to act.
Source: Bloomberg

Some determined investors are on the wrong side. They're still plowing into the very long end of the sovereign market, searching for yield.

More than 1,700 institutional buyers submitted orders for Saudi Arabia's inaugural 30-year bond last week. The offering was oversubscribed and the securities climbed nearly 2 points in the first day of trading.

Italy's 50-year bond offering was an outstanding success for the seller -- the government received almost 19 billion euros ($20.7 billion) of orders for a 5 billion euro deal.

But buyers are taking a bet on, for starters, a country with one of the world's largest debt piles when measured against the size of the economy, a youth unemployment rate around 40 percent and a banking system with 200 billion euros of problem loans. Institutional investors may have logical reasons for seeking new product to match their liabilities, but the yield on offer is wholly inadequate.

This cannot end well. The problem for investors, of course, is that a bout of inflation would wipe out the fixed returns from bonds.

Inflation's been gone for so long, you could almost forget what it looks like. Almost. Central banks have thrown all of their kitchen sinks at the problem, and aren't going to stop until they get their way.

Fed Chair Janet Yellen's prepared to run the economy hot until prices get back where they belong. The Bank of Japan is explicitly targeting the yield curve. The Bank of England's likely to look through the impact of the Brexit-induced sterling crisis and keep stoking inflation.

This is a showdown between an unstoppable force and an immovable object, and the losers are going to be investors.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net