Bond Market Faces Headwinds and a Lot of Uncertainty Ahead
The bond market shouldn’t be ignored. It could be heading toward immense trouble, and that may create a lot of uncertainty in the coming months and quarters. You see, investors at times ignore bonds, thinking that the bond market doesn’t impact them whatsoever. Don’t be one of those investors.
Bonds could be headed for a crash, and that could take a massive toll on investors’ portfolios.
The market has had a massive run to the upside for the last 30+ years. To give you some perspective, look at the chart below. It plots the yields on 10-year U.S. bonds.
Chart courtesy of StockCharts.com
Remember, when yields decline, it means that prices are going higher.
Why did bonds have a rally over the past 30+ years? The U.S. Federal Reserve and other central banks across the globe were lowering their benchmark interest rates. Keep in mind, when interest rates go down, bond prices increase and yields decline.
Don’t forget, the opposite is true as well; when interest rates go up, bond prices decrease and yields skyrocket.
In 2008–2009, we were faced with a financial crisis and a global economic slowdown. As this was happening, central banks went all in. They dropped their interest rates faster than normal, and this acted as throwing more gas on the fire. It gave a major boost to the bond market.
Central Banks Raising Interest Rates
Fast forward to now. As it stands, we are living in an environment where central banks are raising interest rates. This is mainly because economies are doing fine and, in some cases, inflation is taking a toll.
The Federal Reserve is at the forefront. It’s raising its benchmark interest rates. Consider this: not too long ago, the Federal Reserve had its benchmark rates set at 0.25%. They stand at two percent now and they are expected to be above three percent by 2020.
We are seeing a panic-like scenario in the U.S. bond market especially.
The chart below shows the yields on two-year U.S. bonds over the last two years.
Chart courtesy of StockCharts.com
In August 2016, yields on two-year U.S. bonds were around 0.7%. Now they stand close to 2.7%, their highest level since 2008. Using simple math, the yields on short-term U.S. bonds have soared by over 280%.
It can’t be stressed enough: yields rising fast suggest that bond prices are tumbling.
Why Should an Investor Care About the Bond Market?
I completely understand, some investors may not have any bonds in their portfolios. But it doesn’t mean they should ignore bonds.
You see, if the sell-off of bonds continues, it could also lead to a sell-off of stocks.
How so? At times of panic in one market, investors usually just sell everything and run for the exit. Therefore, the stock market could come under fire as well.
Beyond this, know that bond yields affect the interest rates on a lot of things. For example, mortgage rates are highly correlated with 10-year U.S. bonds. If 10-year U.S. bonds sell off, it could mean that mortgage rates will soar. Home affordability will go down the drain.
Furthermore, pension funds own a lot of bonds. In the U.S. economy, we already have a retirement crisis. As I see it, a tumbling bond market could only make things worse. If you are not watching that market, you could be a making a big mistake.