Bond markets think central banks are about to get tough. The yield on the benchmark ten-year US Treasury bond has risen above 2% for the first time since 2019 following this week’s data showing that US inflation hit 7% in December. Investors are betting that the Federal Reserve will be forced to raise interest rates seven times this year to get price rises under control.
Typically, investors demand higher yields for holding bonds that mature further in the future: the US two-year Treasury pays less than 1.6%, compared with 2% for the ten-year, say Davide Barbuscia and David Randall on Reuters. However, “yields of short-term US government debt have been rising fast this year, reflecting expectations of a series of rate hikes” while “longer-dated government bond yields have moved at a slower pace”. Hence the gap between the yield on short- and long-duration bonds has been falling. This trend – referred to as the yield curve “flattening” – implies that investors think tighter monetary policy will lead to slower growth.
So far, the bond sell-off has been “relatively broad and orderly”, says Marcus Ashworth on Bloomberg. Investors are starting to distinguish between classes of bonds again: riskier bonds have seen their yields rise more than safer government bonds. “Italy’s yield premium to Germany… is at the widest for more than a year.”
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Still, last year was the global bond market’s worst since 1999, says Mark Tinker in the Australian Financial Review. The start of 2022 has also been “absolutely terrible”. After years of almost free central bank money and expectations of low inflation, the market is now being forced to reprice. Inflation is soaring and central banks are preparing to sell some of their bond holdings. “The question for long-term investors… has to be ‘why own any bonds at all?’.”
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