The dangerous cocktail of rising global bond yields and falling inflation.

QE adjustments required

Core CPE inflation has been falling all year in the US and is now back down to 1.4pc. Real interest rates are therefore galloping higher.

The change in supply of government debt - the part that will no longer be soaked up by the central banks - will ratchet up towards $3 trillion a year quickly as the US Federal Reserve reverses QE, and others follow.

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This time developing countries can no longer be counted on to snap up the West's safe-haven bonds. Saudi Arabia is running down its foreign exchange reserves by almost $100bn a year to cover its budget deficit. Several OPEC peers are in the same boat. China, East Asia, and Latin America are accumulating reserves at a much slower pace than a decade ago.

The Fed is expected to start selling its bond portfolio as soon as September. Within a year after that it plans to dump $50bn of US Treasuries and mortgage bonds on the market each month.

The Bank of Japan is quietly cutting back its QE purchases. The pace has shifted down from around $60bn a month to nearer $40bn. Hiroshi Shiraishi from BNP Paribas said the authorities are “technically tapering”.

ECB limits

The European Central Bank is nearing the limit of what it can buy. Under a self-imposed rule it may purchase no more than 33pc of the bond issues from each eurozone country. The ECB will soon hit this cap in Portugal. It may do so in Germany and Finland by early Spring, and in Holland and Spain shortly after.

It would be extremely hard for the ECB's Mario Draghi to change the rule, except in an emergency. Under pressure from Germany's Bundesbank, the ECB has tied itself to the mast by declaring that going further would be tantamount to central bank financing of fiscal deficits - banned under EU treaty law.

Closely-watched "breakeven" rates are warning that US inflation will still be just 1.62pc five years hence. What are the markets are really saying is that the world's biggest economy still has one foot in deflation. The eurozone is even deeper into this trap. It has looks all too like Japan.

Mr Rajan said the structure of global finance is badly out of joint. Bond and equity markets are telling different stories. Their messages are incompatible. The worry is that highly-priced equities will have to capitulate to restore the equilibrium.

Central bankers are keeping their fingers crossed. While there is no 'pact' as such by the Fed, ECB, the Bank of Japan, the Riksbank, the Bank of England, and others, they are co-ordinating closely. The calculus is that if they move methodically together this will steady markets.

It is no coincidence that most were singing from the same hymn sheet at the ECB's annual forum last week in Sintra, Portugal. The fond hope is that none will be singled out for rough treatment and that wild swings currencies will be averted.

But as the military saying goes, no battle plan survives the first encounter with the enemy.

@mindhunter

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