Trouble for stocks has often been a boon to bonds in recent years. But this week’s turmoil seems unlikely to have the same outcome. The economic backdrop is simply too bond-unfriendly.
Even the Bank of England, which faces uncertainty around the impact of Brexit on the U.K. economy, Thursday said it could raise rates faster than it had anticipated due to the strength of global growth. That pushed 10-year U.K. gilt yields up to their highest in nearly two years.
Bonds did rally as the worst of the stock selloff hit. But zooming out from daily movements, bonds clearly have their own momentum. While stocks have given back their gains for the year, bond yields are far higher than they were at the start of 2018.
The latest downdraft in bonds started in September, when the 10-year U.S. Treasury yield hit a low for 2017 of 2.04%. It now stands at 2.87%, very close to its high for the year. The 10-year Treasury has returned minus 3.4% so far this year, according to Bloomberg Barclays index data. That looks like a more significant move than a blowoff in stocks that followed a startlingly steep run-up in January.
If stocks can rebound because the economic logic underlying their gains hasn’t changed, then it hasn’t changed for bonds either. In other words, investors are digesting an outlook where global growth is solid, central banks are reducing their stimulus, and the worry is that inflation is picking up.
Those are exactly the forces—combined with technical concerns about greater supply of bonds as the U.S. expands its budget deficit, and central banks cut back on stimulus—that have driven bond yields higher and favored stocks in the past year. Unless the economic outlook deteriorates, or central banks show signs of concern about market moves and hint at softening their stance, there seems to be little reason for bonds to rally.
Selloffs in the past few years in the bond market have been characterized as “tantrums,” and the lack of inflationary pressures has meant they have reversed. But this time the move is more fundamentally driven, and thus has more staying power. That is the mark of a dip that shouldn’t be bought.
Write to Richard Barley at firstname.lastname@example.org