Suddenly, my inbox is stuffed with analyst warnings of an impending global bond rout. It happens, from time to time, this sudden flurry of concern about looming disaster. Should you take this one seriously?
The panic follows Wednesday’s surge in US 10-year bond yields to a seven-year high of 3.232%. Treasuries were driven upwards by news that the US created an impressive 230,000 jobs in September, up from 168,000 in August, while the ISM non-manufacturing index flew to a 10-year high of 61.6. The US is going great guns.
The faster the economy grows, the faster the Federal Reserve will have to hike interest rates to stop it overheating. This is driving up bond yields as investors demand a higher return, while hammering bond prices.
Rise and fall
Some people struggle to get their heads around government bonds, which are issued to raise funds and pay a fixed rate of interest, with a promise to return your capital on a set date. The key thing to remember is that when bond yields rise, prices fall (and vice versa). This means prices are falling now.
The impact can be brutal, as Ben Kumar, investment manager, at 7IM, explains: “The maths is simple, and inescapable – a 1% rise in the yield of a 10-year bond results in a (roughly) 10% loss of capital.” The size of your losses depends on the percentage of bonds in your portfolio, with cautious investors generally having greater exposure.
If you thought bonds were supposed to be low-risk, then think again. “We believe that the risk to fixed income portfolios is still incredibly high,” Kumar adds. This does not mean you should sell all your bonds, but you might want to make sure you have the right asset allocation.
Further to go
The big worry is that we are just at the start of the interest rate hiking cycle. After eight hikes since 2015, US rates stand at between 2% and 2.25%. Markets are pencilling in another 0.25% rise in December, and three more next year, lifting them to 3.25%. The US long-term average is above 6%.
Other central banks will be forced to follow, driving up global bond yields, and driving down global bond prices. Finally, the 30-year bond bull market may be coming to an end.
Maybe there will be no panic. Investors may be content with two-year yields of 2.85% and 3.2% over 10 years, even if you can get 7.5% from stocks like this one. Pension funds still have to match their liabilities. The global economy looks relatively strong, with the US rising at an annual rate of 4.2% in the second quarter. All may end well.
It may not though. Either way, I feel that shares beat bonds right now. In fact, I have near zero bond exposure, as I have no plan to retire for another 15 years and believe stock markets will offer a superior return over that relatively lengthy period.
But the total bond market is estimated at $40trn, larger than the stock market at $30trn. Rising interest rates and a bond market rout could therefore eventually hurt every one of us.
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harveyj has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.