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Deutsche Bank: Bond Investors Are About to Get Crushed as a New Global Cycle Kicks Off

A new economic cycle is kicking off.

Weak growth, higher inflation, and stagnant productivity in developed countries will roil bond investors in the decades to come, as the benign global forces that have buoyed returns on financial assets for the past 35 years stage a sharp reversal. That's the big-picture call from Deutsche Bank AG analysts who predict an oncoming lurch towards trade and financial protectionism — combined with aging populations and weak worker output — will intensify financial repression as a new multi-decade-long economic cycle kicks off this year.

"In our opinion we're getting closer to a binary outcome for the global economy and financial markets," the strategists, led by Jim Reid, wrote in a report on Thursday.

Now, there's an inflection point in the global economy that is poised to create a perfect storm for bond investors: higher inflation, and strengthening political incentives to erode high debt burdens by hitting bond holders with effective haircuts, the bank argues.

The strategists paint two scenarios for bond holders going forward:

Scenario 1 – The best case

Put bluntly the best realistic scenario for financial stability in the new era is that bond holders around the world see a slow real adjusted haircut over several years, probably over at least a couple of decades. The best example of this through history was the post WWII period where government debt was at similar levels to that currently seen. Over the next 35 years this debt was successfully eroded by a long period where nominal GDP was notably above bond yields. So bond holders took a large real haircut.

Scenario 2 – The hard break

Rather than an artificial reflation and slow successful non-systemic deleveraging, there is a genuine risk of a more binary outcome where a major country (countries) see(s) a hard default on its debt taking a lot of...