Bond markets are tanking. Why?

Bond markets are sinking, with bond yields climbing rapidly. But equity markets are nervous, too – breaking the inverse correlation usually seen between the two. As a result, the well-known 60-40 diversification rule is broken.

Question mark made up of pound symbols

Image source: Getty Images.

There’s something of a meltdown going on in the fixed-interest bond markets, currently. And I’m talking globally.
 
Here in the UK, as I write these words, the yield on ten-year bonds stands at 1.96%: up significantly since the end of last year. Gilts — government fixed-interest bonds — have a similar story to tell.

A chart that I’m looking at on the Financial Times website right now tells me that the UK yield curve for ten-year bonds is up almost 0.5 percentage points in the last month. In the United States, the equivalent figure is closer to one entire percentage point.
 
That’s quite something.

5 Stocks For Trying To Build Wealth After 50

One notable billionaire made 99% of his current wealth after his 50th birthday. And here at The Motley Fool, we believe it is NEVER too late to start trying to build your fortune in the stock market. Our expert Motley Fool analyst team have shortlisted 5 companies that they believe could be a great fit for investors aged 50+ trying to build long-term, diversified portfolios.

Click here to claim your free copy now!

Yield up, prices down

Now, because bond market commentators always talk in terms of yield — mirroring how bonds are ‘priced’ — it’s easy for investors who aren’t bond-savvy to misinterpret what rocketing yields are really saying.
 
What they aren’t saying is that this rising yield is good news for bond investors. Far from it.
 
Fixed-interest bonds are fixed-interest, remember. So the price at which you buy a bond or gilt locks in the return that you’ll get from the periodic ‘coupon’ (as it’s called) that you’ll be paid.

Think of it like a dividend that never changes, however long you hold the share in question.
 
So for yields to go up — and this is the crucial point — bond prices have to go down. Which is what’s happening at the moment.
 
The UK iShares Corporate Bond Index is down 6.5% since the start of the year. Vanguard’s Global Bond Index is down 7.4%.
 
And in the staid world of bonds and gilts, those are big swings. In both yield, and prices.

Fixed interest is, well, fixed-interest

Now, why is it happening? Simple: as I say, fixed-interest bonds (and gilts) are fixed-interest bonds.

Meaning that when inflation rears its ugly head — as it is doing right now, of course — then the value, or purchasing power, of those fixed-interest coupon payments declines.

Bond markets can live with low-level, predictable inflation: markets just factor that into the price, inside the various sophisticated computer models that bond traders possess.

But what bond markets struggle to deal with is the roaring inflation that we’re seeing at the moment — which, post-Ukraine, could climb much, much higher yet.

And faced with such uncertainty, bond prices are plunging.

So what does it all mean?

Two things.
 
First, the capital that’s being pulled out of the bond markets has to go somewhere. And it’s going into equity markets, helping to prop up share prices.

So if you’ve been wondering why share prices have been holding up so relatively well, post-Ukraine — and especially in the context of a post-Ukraine energy shock — then that’s your answer: in inflationary environments, shares tend to offer rather more inflation protection.
 
Second, bond markets and equity markets are normally inversely correlated: when one goes up, the other goes down — which is why the well-known 60-40 asset allocation ‘rule’ (60% shares, 40% bonds) works so well for diversification and capital protection purposes.
 
Except that this inverse correlation isn’t happening now, though: the link is broken. And in fact, following the 60-40 rule could actually lose you money.

Bond bargains ahead?

It depends what you mean by ‘bargain’.

At some point bonds will be cheap (or rather, their yields will be higher than they are now, in other words). Inflation will be tamed at some point, and bond prices will have sunk to new lows.

But I reckon that it will be a brave private investor who buys in at that point, having seen first-hand just how quickly bond investors can see their capital evaporate as inflation takes hold — which of course, it might very well do.

Certainly, I won’t be buying supposed ‘bargains’ in the bond market.

Inflation Is Coming: 3 Shares To Try And Hedge Against Rising Prices

Make no mistake… inflation is coming.

Some people are running scared, but there’s one thing we believe we should avoid doing at all costs when inflation hits… and that’s doing nothing.

Money that just sits in the bank can often lose value each and every year. But to savvy savers and investors, where to consider putting their money is the million-dollar question.

That’s why we’ve put together a brand-new special report that uncovers 3 of our top UK and US share ideas to try and best hedge against inflation…

…because no matter what the economy is doing, a savvy investor will want their money working for them, inflation or not!

Best of all, we’re giving this report away completely FREE today!

Simply click here, enter your email address, and we’ll send it to you right away.

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Arrow symbol glowing amid black arrow symbols on black background.
Investing Articles

Has the ASOS share price bottomed?

After a massive fall, ASOS shares have started to edge back. Edward Sheldon discusses whether the stock has now bottomed.

Read more »

Arrow symbol glowing amid black arrow symbols on black background.
Investing Articles

An under-the-radar FTSE 100 stock to combat stagflation fears

As the share price of this blue-chip FTSE 100 stock falls below Covid-levels, why I added it to my portfolio.

Read more »

Man smiling and working on laptop
Investing Articles

This stock market sell-off could be my buying opportunity of the decade

The market sell-off has been brutal, but this Fool thinks it offers him a compelling opportunity to make big money.

Read more »

Typical street lined with terraced houses and parked cars
Investing Articles

After falling 60%, is the Ocado share price a bargain?

The Ocado share price has fallen heavily in the past year. But our writer is still not buying it for…

Read more »

Hedge shaped as the pound symbol inside a glass piggy bank
Investing Articles

A question investors need to ask about the Woodbois share price

The Woodbois share price has declined a little from its peak in early May. Does that mean I should buy…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

3 value stocks I’d buy right now

Roland Head thinks market conditions could favour value stocks over the coming year. He’s found three he’d like to buy…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

These 5 FTSE 100 shares have crashed in 2022. I’d buy one now

These five FTSE 100 shares have plunged in value over the past six months. But I believe one of these…

Read more »

man in shirt using computer and smiling while working in the office
Investing Articles

Is Scottish Mortgage Investment Trust now a bargain growth stock?

The Scottish Mortgage Investment Trust share price has plummeted nearly 50% from its 52-week high. Is this a great opportunity…

Read more »