Monetary tightening Drew Angerer/Getty Images

The Coming Financial Volatility

Bond investors are from Mars, and central bankers are from Venus – or so suggests the bond market’s negative reaction to signals that the exceptional monetary-policy accommodation of the last decade is winding down. Are risky asset markets right to ignore the red flags that the bond markets are waving?

LONDON – Bond investors are from Mars, and central bankers are from Venus – or so suggests the bond market’s negative reaction to signals that the exceptional monetary-policy accommodation of the last decade is winding down. Risky asset markets, however, are ignoring the red flags that the bond markets are waving. Are they right?

Today, inflation remains low in much of the developed world. But previously dovish central banks in countries like the United States and the United Kingdom are itching to roll back the accommodative monetary policies that they have pursued since the eruption of the global financial crisis of 2008.

Inflation-targeting central banks assume that, when inflation expectations are stable, changes in inflation stem from changes in the amount of slack in the economy. When slack diminishes – as is happening now, with unemployment now well below average levels over the business cycle (and at multi-decade lows in the US and the UK) – inflation will eventually rise.

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