Bonds still weakening in ‘bloodbath’; some wonder ‘is this it for bonds?’

Bonds are sliding again, and market watchers are getting very nervous.

At pixel time, this is the score:

• UK 10-year yields shot up by 0.1 percentage points yesterday. (Yields rise when prices fall.) In the opening moments of trading, yields are flat at 1.25 per cent, but it’s very early days.
• 10-year Bund yields are climbing again after a 0.085 percentage point rise yesterday. They’re up by 0.012 percentage points.
• US Treasury yields are up by 0.01 percentage point to 1.865 per cent.

Is this the start of a bigger drop in core fixed income? Game over? Most suspect not, but with a good dose of gloom thrown in. (This is the bond market after all. People in this business have a reputation for being miserable to uphold.)

Rabobank describes the sell-off as a “bloodbath”:

Obviously this is a challenge to the view we often espouse of a secular stagnation/new normal that drags down bond yields and flattens curves. Nonetheless, if we look at the recent news-flow we may be able to see beyond this bond bloodbath.

The Fed are looking likely to raise rates again in December: Williams overnight stated this is the “best time” to do so: seasonal cheer to US households? Yet US data are patchy. For example, core durable goods orders yesterday were -1.2% vs. an expected gain of 0.1%. Today’s Q3 GDP print will be closely watched, but expectations at 2.6% mean the US is performing well below its pre-crisis norm.

Another theme explored this year is that populism might be a trigger for higher yields and steeper curves. However, right now it is a case of The Empire Strikes Back. For example, the Canada-Europe Trade Agreement CETA appears to have been brought back from the dead despite Walloon objections, though it still needs to be ratified.

ANZ reports that “markets are becoming increasingly nervous about whether this is ‘it’ for bonds, and that yields are now set to march ever higher.”

It has been a remarkable run of course over numerous years, helped by unprecedented central bank policies, lacklustre growth, and a lack of generalised inflation. But is that backdrop now changing? Global inflation is rising off lows, if for nothing else because of base effects, and growth has perhaps been a little better of late too. UK GDP surprised on the upside overnight and US GDP data tonight is expected to show a bounce from first-half softness. EM growth looks to be stabilising as the drags from trade weakness start to dissipate. We have also seen (some) central banks look a little less reluctant to ease further as the efficacy of their policies are tested, and of course the Fed is inching towards tightening. So perhaps this is really ‘it’.

But could yields really be set to grind meaningfully higher? Productivity growth is still poor, leverage extreme, central banks still dovish, and demographic pressures still evident. So while yields could indeed continue to lift modestly (we expect them to), larger moves would require a much firmer economic backdrop and there is still limited evidence of that.

Barclays sounds unconvinced.

At current levels, the yield curve is reflecting a very subdued risk of a downturn over the coming years, which is not consistent with the data, in our view. The unemployment rate has essentially remained unchanged over the past year which, typically, does not bode well for the outlook, judging from the last two business cycles. Overall therefore, we recommend fading the sell-off by going long 10y US Treasuries (at 1.85%).

The recent cheapening of the euro, the back-up in market based inflation expectations and speculation around ECB bond purchase tapering have helped the Bund market sell off, among other global factors. We believe the underlying growth and inflation picture have not turned decisively positive enough to justify sustainably higher bond yields in the euro market yet.