For a decade, the global bond market has seen a major decline

03.09.2022. / 16:00

WASHINGTON/SYDNEY – Under pressure from central bankers focused on cutting inflation even at the cost of a recession, the global bond market sank more than 20 percent for the first time in three decades.

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Bloomberg’s global index of the aggregated total return on government and corporate bonds (Global Aggregate Total Return Index) fell by more than 20 percent from its maximum reached last year, which represents the biggest drop since the index was launched in 1990.

US and European officials have continued to stress the importance of tight monetary policy in recent days after Federal Reserve Chairman Jerome Powell sent a similar message at the Jackson Hole conference a week earlier.

The sharp rise in interest rates in response to high inflation, which was fueled by monetary policy makers, ended four decades of a generally positive trend in the bond market. Such a development creates problems for investors because both stocks and bonds sink at the same time.

“I believe that the positive trend in the bond market, which started in the mid-eighties, is coming to an end,” said Stephen Miller, who has been covering fixed income securities markets ever since, and now works at the investment consulting firm GSFM within the Canadian corporation CI Financial.

“Yields will not return to the historic lows we saw before and during the pandemic,” he added.

The high inflation that the world economy is now struggling with means that central banks will not be ready to re-introduce extremely loose policies and measures like those that have caused government bond yields to fall below one percent, according to Miller.

The simultaneous decline in the bond and stock markets is undermining the foundation of investment strategies that have been valid for the past 40 years and beyond. Bloomberg’s bond index has lost 16 percent this year, and the MSCI index of global shares has sunk 19 percent.

This year, the American benchmark of the classic ratio of 60:40 for portfolio investments – where the investments are divided between stocks and bonds – has moved down by 15 percent this year, which is on track for the worst result since 2008.

“We’re in a new investment environment, and it’s going to be a big deal for those who were hoping to diversify their risk away from stocks by investing in bonds.” said Kellie Wood, director of fixed income investments in the Sydney office of UK financial corporation Schroders.

Bonds suffered the most in Europe

European bonds suffered the most this year because the Russian invasion of Ukraine caused an enormous increase in the price of gas. Asian markets suffered somewhat less, due to Chinese debt, as the country’s central bank tries to loosen policy to stimulate the economy.

Differences in yields on dollar bonds last month narrowed to the highest level since 2020, so those spreads narrowed faster than on US bonds, which has only happened a few times in the last ten years.

The turnaround from extremely loose monetary policy to the sharpest interest rate hike since the 1980s has cut liquidity in most of the world, JPMorgan Chase & Co. says.

“In the bond and foreign exchange markets this year there was a more serious deterioration in liquidity than in other types of assets with no signs that this will reverse”notes the team of London analysts headed by Nikolaos Panigirtzoglou.

Negative momentum in bonds is approaching extreme levels, they added.

The realities of economic policy that investors now face are in many ways reminiscent of the negative trend of the bond market during the sixties, which began in the second half of that decade when the period of low inflation and unemployment ended.

As inflation accelerated during the 1970s, benchmark yields on government bonds soared. By 1981, they had reached nearly 16 percent after then-Fed Chairman Paul Volcker raised interest rates to 20 percent to quell rising prices.

While explaining his policy in Jackson Hole, Powell looked back to the 1980s, saying the historical record clearly warned against loosening policy too soon.

Market players now estimate the probability of the Fed’s third straight rate hike by 75 basis points later in September at nearly 70 percent.

The demand is there

Other central bankers, from European to South Korean to New Zealand, who were present at the conference, also made it clear that they would continue to raise interest rates.

But investors in fixed-income securities continue to buy government bonds, even as their yields rise, expecting that monetary policy makers will have to reverse their beliefs if the slowdown in the economy also lowers inflation. In the options market in the United States, they are still counting on at least one interest rate cut of 25 basis points next year.

“I would not declare the current changes as a new negative trend on the bond market, but rather as a necessary correction of a period of unsustainably low yields”said Steven Oh, global head of credit and fixed income at PineBridge Investments.

“We expect yields to remain at low levels by long-term historical standards, and 2022 will probably be an example of the peak of ten-year bond yields in the current cycle,” he added.

At Schroders, they also see an opportunity in government bonds, and with rising yields, they are adjusting the portfolio to the real risk of a serious economic slowdown, notes Wood.

“In the not-so-distant future, this will be a great opportunity to buy bonds, because central banks almost guarantee us a global recession,” she said.

Bloomberg Adria


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