Chart of the week: 1994 – a guide to things to come?

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Rising inflation expectations and the prospect of continued, and possibly accelerated, monetary policy tightening by the Federal Reserve have pushed US equity markets (here, the S&P 500 index) into correction territory. The question now is whether the combination of steady global growth and modest inflation – termed ‘Goldilocks’ – is coming to an end.

Global bear markets in bonds are infrequent with 1994 providing a rare example. In that year, bond markets suffered a sharp and abrupt sell-off that began in the US and Japan and then spread across all developed markets.

A subsequent analysis by the Bank of International Settlements concluded that the bond market’s own dynamics provided a stronger explanation than variations in market participants’ apprehensions about economic fundamentals. In short, volatility begets volatility, particularly after long periods of low volatility conducive to complacency.

This week’s graph of the week shows changes in the fed funds rate, the yield of 10-year Treasuries and the S&P 500 index over the course of 1994:

Note: S&P 500: December 1993 = 100. Source: Bloomberg, BNP Paribas Asset Management, as of 05/02/2018

  • In 1994, fed funds rose by 250bp and 10-year US Treasury yields by 200bp
  • Peak to trough in the first quarter, the S&P 500 index fell by 8.5% (total return) versus a 5.8% decline for the Barclays US Aggregate bond index
  • Equities recovered through the end of 1994 – despite further increases in yields – to post a 1.3% gain.

 

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