The jungle drums are starting to beat in the bond markets. Last week saw some significant moves in yields which have now moved back above 1 per cent in the case of the UK 10-year benchmark gilt. 
Janet Yellen, Fed chair, made a speech on Friday to Boston academics and policyholders and made reference to a ‘high-pressure economy’ which may be required to reverse damage from the 2008-9 crisis which risks becoming a permanent scar.
This is still being analysed by many as to precisely what it means. At the very least, it infers a recognition that all the liquidity stimulus, monetary easing and QE that has been implemented over the last seven years has failed to reinvigorate the US economic machine which is, at best, sputtering in a low-growth world despite all efforts to encourage the contrary.
It also suggests that the Fed is preparing to play fast and loose with the control of inflation and that a program of fiscal stimulus may be the latest tonic to hit the economy.
Expectations ahead of the UK chancellor’s Autumn Statement on 23 November are painting a similar picture.
Monetary easing has run its course, saved the economic system in the West but has now reached its limits in terms of stimulating demand. It is not really a surprise that any policy stimulus that remains firmly in the wholesale money-markets has done little to spur demand, which comes from the consumer.
Performance of indices over 8yrs
Source: FE Analytics
In the process of implementing QE, all asset classes have risen, as investors have reallocated assets elsewhere, but this only serves to make investors richer and does little for the man on the street who does not feel any wealthier.
Janet Yellen’s comments are hardly supportive of a December rate rise, which is now 65 per cent probable according to the surveys of market opinion. However, it does suggest that the Fed sees inflation on the rise and is setting their stall out ahead of that so that if they don’t act, as it rises, we have all been pre-warned not to panic.
In the UK inflation rose from 0.6 per cent to 1 per cent, demonstrating the first evidence that the devaluation of sterling is feeding through into import costs, an element of which is being passed on to the end consumer.
Evidence of margin pressure abounds within the UK retailing space with cautious statements from many clothing retailers and the Unilever/Tesco spat last week revealing much. Added to this is the oil-price effect where the price falls of 2014/15 are now dropping out of the year-on-year figures and in fact, prices are on the rise, partly due to increased import costs but also the recovery in the oil price.
Psychologically, market participants are much more sensitive to upside inflation than downside, even if the same technical explanations are made as to why we shouldn’t get emotional.
Additional downside inflation is a bonus and although it is a technical feature of say weak commodity prices, and artificial, it is still welcome and fortunate. Additional upside inflation, of whatever technical form it may take, is unwelcome, and if it disguises real inflation (the bad type) then investors will get spooked.
Whilst it persists, and with central bankers saying they are prepared to tolerate it going forward, bond markets could get the jitters as fears mount that we are behind the curve and things are about to get out of control.
The actual degree of control that a central bank has over inflation is a moot point. Observe how difficult it has been for the Bank of Japan to keep inflation positive despite negative interest rates and huge QE. The same goes for Europe and to a lesser extent, the UK and the US.
If the central bankers cannot successfully get inflation to rise back to their 2 per cent target after all the extraordinary and extensive measures implemented over the last few years, then why should we have any confidence that the very same impotent tools they have been using up to now will suddenly start working if inflation starts rising?
It is a very scary thought that the amount of liquidity stimulus that has been deployed in the global economy may also prevent interest rate rises from being effective in curbing inflation if it exceeds the 2 per cent target.
However, before getting hysterical, we need to take a step back and think about the drivers of this forthcoming inflation.
Firstly, the oil price rise is very muted and unlikely to rise much above $55-$60 as the days of $100 oil are long gone with the rise of fracking. The US has taken over from Saudi as the world’s swing producer, not based on quota agreements but profit and loss dynamics which is far more reliable.
Performance of sterling vs US dollar over 3rs
Source: FE Analytics
Secondly, the effect of the fall in sterling only affects the UK economy and rises in import costs will be diluted down as they find their way to the consumer. Hawks will be watching the price of Marmite and many other Unilever products very closely, to see where the compromise of that particular spat has been distributed – most likely shared between all three.
Whichever way you look at it, there is a general consensus emerging that we are going to see a rise in fiscal spending around the world, for similar reasons as that seen in China, which incidentally reported a 6.7 per cent economic growth this week.
They famously deployed $500bn of infrastructure spending to protect their economy from the collapse in demand for exports manufactured in China as the crisis of 2008/9 took hold. Whilst there is much talk about bad debts and misallocated resources, the principle, if deployed on commercially viable terms, could provide a welcome fillip to economic growth and confidence.
However, the big issue is the funding. China was awash with cash following its export explosion and a massive trade surplus. This is not the case in the West and so it will be fascinating to see how the authorities plan to pay for any fiscal investment.
Guy Stephens is managing director at Rowan Dartington Signature. The views expressed above are his own and should not be taken as investment advice.