The end of the 30-year bull markets in bonds has been proclaimed more times than supposed sightings of Elvis. But just as every resurrection of the King turned out to be false so it has been with bond markets as yields in US, German and UK government debt have ground ever lower.
The clamour in the past few weeks, however, of traders and strategists calling a turning point for bond markets has been unusually strong. Many in the market see parallels with 1993-94, when US benchmark yields rose from 5 to 8 per cent in 12 months. Others have cited March 2009, when global equities rebounded so strongly after the financial crisis.
UBS has made one of the stronger arguments, saying that the sell-off will be sporadic, rather than continuous, as investors begin to challenge the commitment of the US Federal Reserve to its ultra-low rates policy up to 2014.
I’m not convinced that the bull market is finished. In a normal world, the recent run of better economic data that have come out of the US, in particular, should lead to higher yields. By most reckonings, 10-year yields should be in the 3-4 per cent range, rather than the current 2 per cent for Germany and 2.3 per cent for the US and UK.
But this isn’t a normal world. Bond markets have become a tool of western policymakers, with low yields explicitly targeted by the Fed and Bank of England. If things got out of hand and yields shot up too quickly, driving up borrowing costs for households and companies, then the Fed would be expected to act. There is likely to be extreme nervousness among central bankers and politicians if the cost of capital for consumers and homeowners jumps.
So far, the recent back-up in yields has been sharp but not overly dramatic. In two weeks, the US 10-year yield has gone from 1.95 per cent to 2.31 per cent by Wednesday. Its low this year was 1.79 per cent in late January, but that is one of the lowest yields in at least 60 years, suggesting some kind of sell-off was inevitable.
A second big reason for the lack of normality is the likely temporary nature of the two main forces behind the fall in Treasury prices and concurrent gains in risky assets.
First, much like last year, there are considerable worries about prospects for global growth in the second half of the year as austerity bites harder in Europe and, potentially, even the US faces a degree of fiscal tightening.
Many are hoping that the recovery will continue, but plenty of economists fret about the bumps that lie in the road ahead.
Second, while the eurozone debt crisis appears to have stabilised, this relative calm is likely to be short-lived. George Magnus, senior economic adviser to UBS, delivered a blunt assessment in a Financial Times interview this week, saying: "I’m afraid I don’t think this problem has been solved at all. I think it has been put to rest for a time.”
True, the European Central Bank’s provision of more than €1 trillion of cheap loans to banks, under its longer-term refinancing operations, has bought some time for the financial system, which has been saved from a lending freeze, and Europe’s heavily indebted nations, whose borrowing costs have fallen back as a result.
But, by in effect encouraging banks, particularly those in Italy and Spain, to buy domestic government debt, the ECB has tied the fates of these banks even more closely to their sovereigns. That cannot be healthy in the long run.
From one perspective, it looks like bonds are merely playing catch-up with the rest of the financial markets. Looking at the movement in all asset classes this year, equities and commodities are among those that have returned to their levels of last year. Bond yields have not yet done that but are on their way. It is worth remembering that in just three weeks last summer US 10-year Treasury yields tumbled from 3 per cent to just above 2 per cent as the eurozone crisis intensified, imperilling the wider global recovery.
So bond yields could well continue rising. Indeed, in the past 50 years, US benchmark yields have been below 3 per cent only in the aftermath of the 2008 financial crisis. But they are likely to stay near these historic lows for some time yet.
A more difficult question is to know whether government yields could test their multi-decade lows again. Albert Edwards, a strategist at Socit Gnrale known for his bearish views, thinks so. He said yesterday that new lows would soon be hit. But UBS notes that the low of 1.67 per cent, touched in late September 2011, is unlikely to be tested unless global growth goes into reverse.
Futures markets also call for a normalisation in the medium term. So-called "5-year 5-year forwards”, a measure of expected rates five years out, suggest that yields will rise over time to levels that look less extreme by historical standards. But their rise has been somewhat more muted than that of bond yields, according to Pimco, meaning that over the longer term investors have been less surprised by recent events.
Much depends on policymakers, of course. Their task of trying to influence the direction of so many assets – be it bonds, equities or oil – at the same time is becoming ever trickier. The bond bears will stay caged for now, but a breakout may not be that far off.
Copyright The Financial Times Limited 2012.