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Is this the beginning of a bear market in bonds?

The bull market in bonds has lasted for 35 years, but could it finally be coming to an end? Some influential investors think so.

Is this the beginning of a bear market in bonds?

Investors are preparing for a bear market in bonds, following a disappointing start to the year.

Government bond prices have experienced a pronounced sell-off so far in January, with yields, which move in the opposite direction to prices, spiking.

Yields on 10-year US treasuries have hit 2.72%, their highest level since 2010. Earlier this month, renowned US bond manager Bill Gross declared the start of a 'bond bear market', while his fellow fixed income heavyweight across the pound,  Jeffrey Gundlach, said he expected a continued rise in yields through the course of the year.

The jump in yields is significant because it threatens to derail the 35-year bull market for bonds. If this is the case, investors will need to re-evaluate how they allocate to bonds.

Richard Woolnough, manager of the £22.5 billion M&G Optimal Income fund, believes the bond market has reached a ‘crucial inflection point’. 

‘Due to US leading indicator data, the added impetus of tax cuts, strong synchronised global growth, and the return of the missing link of US confidence as I outlined last year, I think the probability of the recent bear market in bonds stopping at this point is limited and it is why I remain short duration across my portfolios,' he said.

Expressed in years, duration is the measure used to show a bond fund’s sensitivity to interest rate changes. Rising interest rates are bad for bonds because it makes their returns look less attractive. Rates also tend to rise when inflation is increasing, which erodes the fixed income that you lock into when you buy a bond. Inflation expectations – upwards or downwards – can therefore have a significant influence on the performance of the bond market.

Don't bet against central banks

Peter Elston, chief investment officer at Seneca Investment Managers, notes that inflation needs to remain very low for developed market bonds to offer real returns. In his opinion, this scenario is unlikely because it runs contrary to central bank policies around the world.

‘For real returns [after inflation] from bonds to be in line with their long-term average of around 2% per annum, inflation must be negative. And for the high real returns seen over the last 35 years to be sustained, the scale of deflation has to be unprecedented,’ Elston said.

As central banks are doing everything in their power to avoid deflation, the chief investment officer believes that the investment case for bonds looks negative right now.

‘The point is that it is very possible that we will not see the deflation or very low inflation that would enable decent real returns from bonds. Central banks have worked it out. Do you really want to bet against them?’ he asked.

David Absolon, an investment director at Heartwood Investment Management, expects to see higher inflation in the US this year. Back in December, core inflation stood at 1.8%.

He is forecasting global economic growth to translate into higher demand and spending, which will ultimately feed through to prices. Likewise, an uptick in oil prices will also have an impact.

‘Admittedly wage growth has been disappointing so far, but we expect that tighter labour market conditions will eventually feed into higher wage setting,’ Absolon added.

The investment director is particularly nervous about the potential for higher inflation at a time when central banks across the globe are moving from quantitative easing to quantitative tightening (a phrase which refers to the withdrawal of stimulative policy).

‘Reduced global market liquidity is likely to receive more market attention as the year progresses. While the Fed is already reducing its balance sheet, the European Central Bank will end its asset purchase programme in September. Furthermore, the Bank of Japan has already announced that it will reduce longer-dated Japanese government bond purchases,’ he added.

He suspects the end result will be increased volatility in the bond market in 2018.

Time to buy?

Chris Iggo, fixed income chief investment officer at AXA Investment Managers, expects inflation numbers to firm up in 2018, driven by higher global economic growth. Nevertheless, he points out that interest rates and yields remain low relative to history.

‘Yields are rising but it is no bond rout,’ he said. ‘There is not likely to be a rout until there are signals about a change in monetary guidance from Frankfurt or Tokyo. Until then, yield starved investors in Europe and Japan will continue to be supportive for fixed income markets.’

The flipside of falling prices is that yields will rise; once the 10-year US treasury yield reaches 3% it will represent an important milestone, Iggo says. This is because it represents a yield level that is likely to attract investors back into the asset class. Notably, this would include institutional investors, such as pension funds.

‘If we get to 3% in US treasuries and close to 1% in [German] bunds, it's probably time to buy,' he said.

7 comments so far. Why not have your say?


Jan 29, 2018 at 11:29

"Admittedly wage growth has been disappointing so far"

It will not be long before they are complaining that increased wages are causing inflation! Never happy!

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Jan 29, 2018 at 15:14

Yet again, clarification is lacking as whether "bonds" refer to Government bonds (Gilts) or Corporate bonds.....or both?

For the past ten years or so, we have been getting regular claims that the bond run "is ending", yet mine go on rising steadily (if unspectacularly) and paying a worthwhile monthly or quarterly dividend.

So why is this time "different"?

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Hugh M

Jan 30, 2018 at 06:08

Yet again, clarification is lacking as whether "bonds" refer to Government bonds (Gilts) or Corporate bonds.....or both?

Very true, maybe it's brooke bonds, who knows?

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Jan 30, 2018 at 10:40

Angl29 is right in that the end of this bond bull run has been predicted before. However the voices now joining in include people who have made a lot of money out of that run.

Rationally interest rates are on the rise, accompanied by a reduction in central bank purchases, and this can only push the fixed interest market in one direction. Sure there may be some wobbles along the way, but this trend seems likely - unless the next recession hits first. What happens than is anyone's guess as we are in uncharted territory due to the scale of QE.

Anyone sitting on top of a lot of expensively acquired long-dated bonds is likely to make significant capital losses either way, and this includes many pension funds. Personally I have already banked all the gains on my directly held bonds except for index-linkers and short duration ones bought below par.

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Jan 30, 2018 at 12:21

horshamtim: 2 points.

You mention interest rates "on the rise". Yet it's reported "very unlikely" that the outgoing Yelland will put up rates in the US next time round. Also I would think our government will be doing all in its power to persuade the Bank of England not to raise rates; May has a wafer thin majority and with "Calamity Corbyn" waiting in the wings, the last thing she will want to do is alienate countless thousands of voters already struggling to meet mortgage payments.

Secondly, even if there is a rise, its almost certainly not going to be more than 0.25%. Surely not enough to cause ructions in the bonds market?

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Stephen B.

Feb 03, 2018 at 12:03

The UK government issues gilts for up to 50 years ahead, so the big issue is not so much what happens to interest rates this year, but what people expect for decades into the future. At the moment a quick google search says that the 50-year gilt yield is 1.74%, which is extraordinarily low - given a 2% inflation target that implies a negative yield in real terms. Even a fairly small increase in that yield has a big impact on the price because it gets compounded over such a long period.

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Feb 05, 2018 at 09:25

Anglo29 - We must be reading different bits of the financial press! In my world it is expected that interest rates in the US will go up again next month, and the yields on 10 year Treasuries - a key indicator - are at their highest for some time. The Fed has also stated that it will seek to "normalise" its balance sheet to reverse the QE process, which by itself will suck liquidity out of the markets. In Europe long tern bond yields have risen on the German Bund and the ECB is also slowing down their QE. Rising yields inevitably mean falling prices. All those who have bought such bonds above their face value are likely to make a capital loss whether they sell before the maturity date or not. Stephen B's points are spot on, and it amazes me how many people don't look at the real yields on their investments.

I am sure that May - for the remaining time she is PM - will hope that interest rates don't go up again, but they probably need to and the decision is notionally no longer a political one. The evidence from the past is clear that the longer such actions are delayed, the bigger the rise later. The really scary issue at the moment is what happens if the next recession hits before the QE has been reversed - the Central Banks have much less firepower left and the developed World is far more indebted than it was 10 years ago. Corbyn may be one of the smaller worries.

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