(Bloomberg) - We may not be in a bond bear market, but we are in a bearish market for bonds. A dangerous one, even.
This has been clear for months: with minimal coupon protection, exceedingly long duration and super-tight credit spreads, the powder keg was fully loaded. Now we have sizzling inflation and hawkish central bankers providing us with the spark.
Some strategists are declaring we’ve entered a bear market for bonds already (or at least a “mini” version of that). The European Central Bank meeting last week was the latest policy surprise contributing to a rapid reassessment of where rates are headed. And credit spreads are widening at the same time as yields are rising, exacerbating losses.
But defining a bond bear market can be subjective. Do you go with yields? If so, which market? Which tenor? Ten-year Treasury yields may be the best option -- and it’s tricky to say the current pace or extent of increases is particularly abnormal there. The long-term downtrend for yields looks intact!
More Pain
Absolute returns give a clearer readout on the bottom line. The Bloomberg Global Aggregate Index had a negative return for the past six months, 2021 was its worst year since 1999 and this year has started off just as nastily. But we’ve seen bigger draw-downs from peak to trough before, in 2008 and 2016, for example. Could we get to a 20% drop? Maybe, but we’re currently only at -7.5%, so that would mean a lot more pain to come.
But the constituents of aggregate indexes fluctuate and their duration can too. Some people prefer to use TLT as a bond-market proxy instead, which was lower in March last year than it is now, or Treasury futures, which are down a neat 10% from their recent peak.
The elephant in the room is inflation -- which magnifies the dismal performance of bonds (and indeed cash). As Ben Carlson wrote in this 2018 piece on bond bear markets: “The real risk in bonds isn’t nominal draw-downs or losses in the principal value. It is the loss of purchasing power over the long-term due to the effects of inflation.”
Little wonder then that EPFR-tracked bond funds saw their biggest weekly outflow since March 2021 in the week through Feb. 2 -- or that Axa’s Chris Iggo saw all of the 13 fixed-income total return indexes he tracks post a negative return in January, only the fifth month that’s happened since 2012.
Still, bond fund managers may argue that positive carry and rolldown can enable them to outperform cash (and even register positive returns if the curve is steep enough). They can make money in repo markets and leverage too. In that case, even a bear market for bonds doesn’t have to mean a wipeout for bond investors.
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NOTE: This was a post on Bloomberg’s Markets Live blog. The observations are those of the blogger and not intended as investment advice. For more markets analysis, go to MLIV.
By Paul Dobson
