# What to expect from bond markets in 2018
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2018-01-30
Category: INVESTING
Category URL: https://financedigest.com/category/investing
Meta Title: Reflation and US Tax Cuts: Impact on Bond Markets
Meta Description: Discover insights from David Absolon, Investment Director at Heartwood Investment Management, on reflation, US tax cuts, inflation pressures, and the changing
URL: https://financedigest.com/what-to-expect-from-bond-markets-in-2018html

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**David Absolon**, Investment Director at Heartwood Investment Management

- **Reflation sets the tone for the bond markets in 2018.** US tax cuts have shifted the market narrative and represent a large fiscal boost to the US economy, albeit temporary. They will significantly add to the US government debt burden, coming at a time when the US domestic growth is already benefiting from near full employment and rising capital expenditure.
- **Cyclical inflation pressures are rising with or without US tax cuts.** [Higher oil prices](https://www.financedigest.com/wall-street-set-to-open-higher-oil-prices-extend-losses.html "Wall Street set to open higher, oil prices extend losses") are expected to have an inflationary impact on headline measures, as well as the feed through from the likely higher import costs arising from a weaker US dollar. More important, though, will be the culmination of several months of strengthening [global momentum feeding into prices across developed economies](https://www.financedigest.com/imfs-georgieva-sees-darkening-outlook-for-global-economy-rising-recession-risks.html "IMF’s Georgieva sees ‘darkening’ outlook for global economy, rising recession risks"). In our view, inflation is a lagged response to growth since stronger demand should translate into [higher spending](https://www.financedigest.com/uk-maps-out-return-to-higher-foreign-aid-spending-after-covid-cuts.html "UK maps out return to higher foreign aid spending after COVID cuts") and, ultimately, higher prices. Admittedly wage growth has been disappointing so far, but we expect that tighter [labour market](https://www.financedigest.com/spains-labour-market-resilient-as-unemployment-drops-in-nov.html "Spain’s labour market resilient as unemployment drops in Nov") conditions will eventually feed into higher wage setting. Furthermore, the recently approved tax legislation has incentivised [companies to use their tax windfall to boost wages](https://www.financedigest.com/french-unions-unanimously-sign-wage-agreement-with-edf-company-says.html "French unions unanimously sign wage agreement with EDF, company says") and/or distribute bonuses.
- **The nature of the current extended cycle of low interest rates and low inflation is changing.** As we enter a more ‘normal’ cycle, we expect [central banks](https://www.financedigest.com/marketmind-rba-shock-hike-starts-huge-week-for-central-banks.html "Marketmind: RBA shock hike starts huge week for central banks") in developed economies to stay on a journey of withdrawing emergency levels of monetary stimulus and lifting interest rates. While the US Federal Reserve is [ahead of other central banks](https://www.financedigest.com/polish-central-bank-holds-rates-points-to-slowdown-ahead.html "Polish central bank holds rates, points to slowdown ahead"), it is worth noting that despite five interest rate rises since beginning its tightening cycle in December 2015, financial conditions in the US have actually eased over the last year {Source: Chicago Fed National Financial Conditions Index}. There is still some way to go, especially if [inflation rises](https://www.financedigest.com/ftse-100-ends-lower-as-pound-jumps-after-inflation-rises-further-in-june.html "FTSE 100 ends lower as pound jumps after inflation rises further in June") as we anticipate.
- **The US treasury market’s vulnerability to supply and demand pressures is increasing.** US treasury selling in early January was, in part, prompted by [media reports](https://www.financedigest.com/credit-agricole-is-weighing-foray-into-german-car-sharing-media-report.html "Credit Agricole is weighing foray into German car-sharing: media report") that the Chinese authorities may reduce its buying of US treasuries. While these reports have since been denied, the US treasury [market’s reaction is nonetheless indicative of its sensitivity to supply factors](https://www.financedigest.com/car-bulb-market-demand-supply-growth-factors-latest-rising-trend-and-forecast-to-2028.html "Car Bulb Market Demand, Supply, Growth Factors, Latest Rising Trend and Forecast to 2028"). And it is all the more noticeable in an environment where we are seeing a regime shift among global [central banks](https://www.financedigest.com/czech-central-bank-vice-gov-unlikely-to-vote-for-rate-cut-newspaper.html "Czech central bank vice-gov unlikely to vote for rate cut -newspaper") from quantitative easing to quantitative tapering. Reduced [global market liquidity](https://www.financedigest.com/global-liquid-breakfast-products-market-to-reach-us-185-bn-by-2027.html "Global Liquid Breakfast Products Market to reach US$ 185 Bn by 2027") is likely to receive more market attention as the year progresses. With the Fed is already reducing its balance sheet, the European [Central Bank](https://www.financedigest.com/central-banks-ease-off-on-rate-hike-push-in-october.html "Central banks ease off on rate hike push in October") will end its asset purchase programme in September. Furthermore, the Bank of Japan has already announced that it will reduce longer-dated Japanese [government bond](https://www.financedigest.com/lg-says-not-a-forced-seller-of-uk-government-bonds.html "L&G says not a forced seller of UK government bonds") purchases.
- **As central [banks step back from supporting financial markets](https://www.financedigest.com/the-stem-cell-banking-market-to-keep-up-the-digitized-momentum.html "The Stem Cell Banking Market to keep up the digitized momentum"), we expect to see more bond market volatility in 2018.** Shorter-dated US treasury yields had already moved meaningfully in the final quarter of 2017, but longer-dated bonds were still fixated to the low interest rate and low inflation backdrop. Evidently this view is now shifting, and we believe that our long-standing underweight duration [position in developed sovereign markets remains](https://www.financedigest.com/tissue-tapes-market-remains-afloat-amid-covid-19-pandemic-to-surge-positively-projects-fmi-2019-2029.html "Tissue Tapes Market Remains Afloat amid COVID-19 Pandemic, to Surge Positively, Projects FMI 2019 – 2029") the most prudent stance.


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