A humiliating week for the good bears


Towards the end of January, UBS he asked the question that matters most to global markets: “Bond bears are coming out of hibernation, but is it too soon?”

Hibernation was perhaps not the right word. Strong demand and a slump in benchmark interest rates have meant that yields on U.S. government bonds, the centerpiece of the markets universe, have been running fairly well for nearly 40 years. So, less a case of waking up from a winter snooze, more a case of resuscitated deaths.

However, six months later, investors seem to have decided it was really too early. The 2021 Big Wobble Bond was impressive – the 10-year yield on the U.S. government bond jumped as much as 1.77 percent at the end of March, and the first quarter was the darkest for the market in four decades. But this week brought a sharp rebound, leaving yields as low as 1.25 percent, still well above the starting point of the year, but a serious one.

It is worth revisiting some of the origins and key moments of the shock bond.

Their security and stability mean that government bonds love poverty (among other things). So when news about the development of vaccines at the end of last year drew the tempting hope of a return to normal post-pandemic life for the first time, that dragged them down.

The real blow came however from the spectrum of inflation, the real kryptonite of the market while eating into the fixed rate of bond yields. The Democratic party’s success in controlling the U.S. Senate with an early January victory in Georgia has sparked expectations for overburdened fiscal spending. A powerful accepted wisdom has developed from persistent growth, sustainable fiscal support and a Federal Reserve that would keep an eye on rising price pressures.

“The January narrative was a cake in the sky, it was rainbow and fairy dust,” said James Athey, investment manager at abrdn, the asset manager that inexplicably changed its name this week from Aberdeen Standard Investments. (As far as I’m concerned, it’s pronounced “Aberdeen.” I don’t understand it either.)

In this environment, a tremendous surge of seven-year U.S. government debt in February – typically a wet event that will captivate only purists – ended up sparking a heavy drop. Decade yields ended the day some 0.14 percentage points higher, a huge move from typically sedated U.S. market standards.

This served as a reminder that while US government bonds are the foundation of global markets, supporting the price of virtually all the riskiest asset classes in the world, they have their moments of instability under pressure. This is a fault line that can be tested when the Fed further strengthens its breadth.

Even Steven Major, head of research at HSBC links and one of the most well-known and most bullish voices on the road, he said in February he was “eating humble cake.” Around that time, Major slashed its year-end forecast for 10-year yields by a quarter of a percentage point.

Now, however, as Athey notes, investors are lowering some of the more generous expectations around tax spending. Inflation has picked up, sharply, but investors are increasingly confident that a large portion of it seems to be rooted in the inevitable bottlenecks in a rapidly emerging economy from the blocs. And crucially, the Fed reinforced the message that its slightly more relaxed stance on price growth in the post-crisis recovery does not mean abandoning its inflation target. Tax regulators have indicated that the delay in policy fees may come a little sooner than previously anticipated.

The result is a 0.19 percent drop in 10-year yields to last week’s lowest point, even with a small rebound Friday.

A mystery here is precisely what prompted the race to the links. Some of the supposed underlying causes have been kicking around for a few weeks with much more limited effects.

Perhaps the most popular explanation is positioning: investor consensus had become so strong and the trade of reflection too popular. When this position began to unfold, the resulting recovery in bond prices shocked investors who were still short. These species of squirrels can quickly become self-reinforcing.

Major, which is holding at its 10% share of the performance target by the end of the year is not convinced on this front. “Positioning is an ex post rationalization,” he said. “He’s a little intellectual in failure.”

But it suggests that investors should rethink the real drivers of government bond demand even in times of huge issuance. “You can turn them into cash without even moving the price. It’s real liquidity,” he said. “Can you do this with your house?” Can you do with crypto? “

So what next? Of course, it takes two parts to make a market. UBS Wealth Management said this week that it still expects returns to reach 2 percent this year, while the BlackRock Investment Institute is also escaping from government bonds on the basis that lean yields offer little cushioning to compensate against shocks elsewhere in a portfolio.

Major, too, thinks the recovery in bond prices is largely over for the time being. But he added: “We’re not going short, and we haven’t changed our forecasts. We still have half a year to go.”

katie.martin@ft.com



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