Investors have been talking about the end of the bond bull market “for years now”, says Fidelity’s Tom Stevenson in The Daily Telegraph. But “they have been wrong to do so”. In 1981, US inflation stood at 14%, and the Federal Reserve raised interest rates to 20% to squeeze it out. The yield on the ten-year US Treasury, the benchmark for the global debt system, hit nearly 16%. As the bond prices subsequently rocketed (prices move inversely to interest rates), the yield slumped to around 2% in the early part of this decade.
Now, however, the tide appears to have turned. Fund managers Bill Gross and Jeffrey Gundlach – who have built their careers on the 37-year bull market in bonds – both said last week that they reckon the upswing is over. The ten-year Treasury yield has climbed to 2.6% for the first time since March 2017, and is widely expected to go higher from here, thereby confirming that the 1.6% yield seen last year was the secular low.
Slightly more normal
Monetary policy is finally “becoming slightly more normal”, says Oliver Kamm in The Times. The US Federal Reserve has phased out its quantitative easing (QE) or bond-buying programme and now the European Central Bank and the Bank of Japan’s QE programmes are decelerating too. Britain has started raising interest rates. Central banks had been huge bond buyers thanks to QE, but 2018 “will probably mark the first [year] since the financial crisis where major central banks start shrinking their market footprint”, says Robin Wigglesworth in the Financial Times.
Fears that China may be slowing its purchase of US government bonds – which Beijing denies – have given the selling added impetus. Another key difference between today and previous false alarms is the strengthening global economy: it hasn’t been this robust since the financial crisis that began in 2007-08. Bonds should sell off as growth accelerates. “All this creates a good case for sending bond yields a bit higher,” says The Economist’s Buttonwood blog. “But for them to go a lot higher requires the return of inflation, which is still hard to spot”; inflation always damages bond prices because it erodes the value of the fixed payments that bonds make.
But investors don’t expect sustained rises in prices to come soon. The
St Louis Federal Reserve monitors inflation expectations five years ahead. The forecast is currently just above 2%. In most major economies, inflation is around 2%; in the UK, it has just edged down to 3%. Here at MoneyWeek, we have long thought that inflation could come back faster than expected. Until we see signs of that, however, yields are likely to drift upwards gently.