When will the market freak out about rising bond yields?

It was fun while it lasted.

From late 2015 until yesterday, the German government was able to sell investors five-year IOUs at a negative interest rate.

At the peak of the "safe haven" assets frenzy in summer 2016, you'd have had to pay the German government 0.6% interest a year for the privilege of lending it money.

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Imagine if that was your mortgage. "Keep up your monthly payments and we'll write off 0.6% a year of the loan." Not a bad deal.

You would think that something quite as surreal as that couldn't really have lasted for long but it wasn't until yesterday that five-year German bund interest rates turned positive again (and then only briefly).

It's yet another sign that the bond bull market is well and truly over.

This could be the year of the bond fund but not in a good way

Last year was "the year of the bond fund", according to Morningstar, at least in Europe. Fixed income funds (which invest primarily in bonds) saw €270bn poured into them, compared to equity funds on a (still-healthy) €98bn.

To be fair, Morningstar also described 2012 as the year of the bond fund. But back then, they only took in €158bn.

Retail investors have a (not always deserved) reputation for getting to the party late. Fixed income may have been popular in 2017 because bonds did well for much of 2016 and a big chunk of the year was spent in panic about a return to deflation.

But now it looks as though that enthusiasm was yet another warning sign. As Robin Wigglesworth points out, the three biggest exchange-traded bond funds have "suffered their biggest monthly losses" since the market turbulence following the election of Donald Trump.

And it's starting to eat away at the edges of equity market confidence. Markets have hardly had a massive correction stockmarkets in Asia were down by about 1% today but that's a big move compared to the apparently endless smooth march higher that we've enjoyed so far this year.

Investors now seem to agree that markets are euphoric. And while they're not 100% sure of what happens when bond yields rise, and they like to make up comforting stories about it (such as "a wall of cash will rush from bonds to equities") they also realise, deep down, that if falling rates have been good for stocks, then rising rates probably aren't.

How will Janet Yellen sign off on market jitters?

All of this is happening just before Janet Yellen's swan song as boss of the US Federal Reserve. Her final meeting as Fed chairman happens this week, and we'll get her final statement on Wednesday.

It's almost as though the markets want to have a bit of a "taper tantrum" to convince auntie Janet for just a bit more punch before she hands the bartender's job to Jerome Powell, who is taking over at a somewhat tricky moment.

It's quite possible that Yellen might have wanted to sign off with something a bit more "hawkish" than traditionally expected of her. After all, growth is strong, the market's mindset appears to have turned around, and the big risk this year is genuinely seen to be inflation.

It seems that it might be a good moment to wave the good ship America off into the distance with a cheerful, optimistic speech.

Yet at the same time, she won't want to go down in history as the Fed chair who blew it at the last minute. She won't want the S&P 500 to have its first major down day of 2018 in response to her farewell speech.

But what's interesting about this and this also illustrates why a rising inflation environment brings its own challenges for the Fed is that it's hard to see what she would have to say in order to calm markets down.

On the one hand, if the Fed looks willing to stick the course and keep raising interest rates, then the market might have a hard time swallowing that. It's simply not used to monetary policy getting tighter rather than looser.

On the other hand, if the Fed looks more dovish than expected, then there are two concerns. One is that markets wonder what she knows that they don't (is the economy secretly in trouble?). That probably wouldn't be such a problem as in reality, it just means a return to the "Goldilocks" mindset of moderate growth plus an accommodative Fed.

But a bigger problem is that they might begin to doubt the Fed's commitment to tackling inflation, which should in theory push longer-term bond yields up even higher. Because if the Fed isn't going to crack down on inflation before it really gets going, then that spells higher interest rates in the longer run.

Given Yellen's record, I suspect she'll err on the side of caution, and be more dovish than the market expects. Chances are that would have a knee-jerk impact on the S&P in any case.

And the truth is that the Fed's not-so-secret mission if it has one is to let inflation run hot. It's the best way to get rid of the debt after all. And that's also the scenario that would most likely result in a full-blown "market melt-up" of the type that Jeremy Grantham has outlined.

But it gives us a taste of the balancing act to come. The Fed has to pretend to care about inflation while staying just far enough behind the curve to avoid freaking markets out.

At some point, either inflation will run too hot, or the Fed will over-tighten, and this will all tumble down. But I think we're a way from that yet, although we can certainly expect the odd hissy fit from the market on the way there.