A Policy Revolution and a Régime Change

The macroeconomic policy revolution accelerated by Covid-19 implies that central bank policy rates and nominal bonds yields will be less responsive to rising inflation pressures over the medium-term. The potential for higher consumer price inflation over the medium-term is still underappreciated, we think, because the new central bank policy frameworks and global cost pressures are not fully reflected in private sector inflation expectations. Neither is the shift towards a closer coordination between monetary and fiscal policy. Combined with the fact that bond yields remain close to their effective lower bound and that authorities need to rely to a greater extent on fiscal policy, the role of government bonds in investment portfolios as a hedge against risk-off events such as the one in March 2020 is increasingly challenged. In contrast to past inflation episodes, less-responsive nominal interest rates and bonds yields mean that government bonds are also becoming less effective as store of value.