Until September, fixed-income investors had everything going their way. Global inflation has been quiescent, and global growth fragile. Central banks, particularly the Bank of Japan and European Central Bank, have been ever-more inventive in monetary policy. And then June’s Brexit vote hammered yields lower as markets feared turmoil and expected more central-bank responses.
Ten-year bond yields turned negative in Japan and Germany. Even with the US Federal Reserve looking to raise rates, US Treasury yields fell sharply in the first eight months of the year. Long-dated bonds produced spectacular returns: By August 12, UK gilts maturing in more than 25 years had returned nearly 39%, according to Bank of America Merrill Lynch indexes.
But the rally pushed bond valuations to extraordinarily stretched levels. And now the tide has turned: long-dated bond yields have shot higher. Thirty-year US Treasury yields have risen 0.23 percentage point in a week.
The move has its roots in Japan, as disappointment with BOJ inaction at the end of July caused a sell-off in Japanese government bonds. Then markets were disappointed again by the ECB last week. Now both the ECB and BOJ are working on potential changes to their policy mix: In both cases, investors fear they will be less supportive of long-dated bonds.
That has global consequences: the rally in US Treasurys was part of a global move; the back-up is just the same. If it were fears around the Fed driving the market, it would be short- and intermediate-maturity bonds that would be suffering more.
Other supportive factors have faded. Brexit, while it may yet have profound long-term consequences, hasn’t caused a new crisis. And headline inflation should rebound in coming months if oil prices remain in their current range. In economies where banks are the dominant suppliers of credit, steeper yield curves may be no bad thing and encourage lending, perhaps brightening the growth outlook. US income data released on September 13 suggests consumers are well placed to spend.
There are still some powerful constraints on bond yields. Global growth remains uninspiring. Regulation will continue to push banks and insurers into assets deemed to be safe. Central banks are unlikely to turn tail; the mix of policy may change, but it will remain loose, keeping short-dated bond yields low.
Fears about fiscal stimulus may be overdone: It will be a bold politician who challenges orthodoxy and ramps up borrowing in style. Geopolitical risk is high and the Brexit vote shows markets can get political outcomes badly wrong. A sell-off in risky assets like equities, corporate bonds and emerging markets, themselves propelled higher by low bond yields, may generate demand for government bonds.
But at the margin, the environment for bonds is less friendly. Steeper yield curves are the result. Bond yields can stay low by historical standards – just not as low as they have been.
Write to Richard Barley at email@example.com
This story was first published by The Wall Street Journal’s Heard on the Street column