The end of the bond market bull run



For more than 40 years, betting on sovereign bonds from developed countries has required following a simple rule: rates will fall. 10-year US Treasury yields peaked at around 16% in 1981 and, with only brief interruptions, have fallen steadily since, reaching nearly 0.5% during the most acute phase of the pandemic. Bond prices rise as yields fall, so falling long-term interest rates have provided a substantial windfall for bondholders.

Predictions of a reversal of this trend have often failed – investors have periodically questioned how interest could possibly fall, only for rates to reach new depths. Yet this time around, the decades-long investment trend may really, finally, come to an end. Despite a small rally, this week could mark the end of the bond bull run as central banks begin the long, slow cycle of tightening and the long-awaited “normalization” of monetary policy. If not, policymakers have even more reason to worry as it would likely indicate that the rich world is struggling with low inflation and low growth.

The world’s largest central bank, the Fed, has announced that it will start scaling back its asset purchase program in the event of a pandemic, joining central banks in New Zealand, Norway, Canada and Australia all starting to limit monetary stimulus after pandemic largesse. While the Bank of England baffled investors by betting on a rate hike at Thursday’s meeting, a small hike is generally expected next month. Emerging markets tightened even more aggressively: On Wednesday, Poland’s central bank raised rates by 75 basis points, its second hike in two months.

So far, the effect on US bond markets has been limited, with the Fed correctly indicating that any future rate hikes will be gradual and the shift to a more “normal” stance slow; it will reduce the pace of QE asset purchases this month rather than stopping them altogether. In Australia, the country’s 10-year debt rates hit their highest level in two years after the central bank stopped defending its yield target for bonds maturing in April 2024. Even that, however, has always left them close to their all-time lows. Indeed, the three English-speaking banks that made policy announcements this week – the Fed, the BoE, and the Reserve Bank of Australia – have all pushed back market expectations that there would be a rapid policy tightening to combat it. inflation.

Traders and central bankers are rightly cautious that the most fundamental trends driving the slowdown have not dissipated, be it technological change, globalization or aging. western societies. But this is an argument for long-term rates to stay relatively low, even in more normal times, not for them to fall further: None of these factors became more deflationary during the pandemic. In fact, China’s changing role in the global economy is potentially reducing a source of disinflationary pressure. Overall, the bullish case for bonds is now the bearish case for the rest of the world – this week’s monetary policy changes reflect a relatively robust recovery from the pandemic.

There is, however, a more unfortunate way that the bull market can end. If central banks were to lose control of inflation expectations, instead of keeping them anchored around their targets, interest rates would eventually rise without reflecting an improving growth outlook for the rich world. Real rates, after adjusting for the effect of inflation, would remain low even if central bank key rates increase. For this reason, bond traders, like the rest of us, should hope that central banks can “normalize” for the right reasons.



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