How global market plays out depends on bond yields

London

THE direction of bond yields is the key to how the global market will perform in the coming weeks.

A sudden surge in yields in the past week sent shivers among traders and investors. Bond prices plunged, causing a mini panic in equity, precious metals and other commodity markets.

Paradoxically, the bond yield rise reflects greater confidence in economies while vaccines are rolled out.

Since central banks and governments have pumped out money and trillions of aid to stressed businesses and individuals at a time of critical supply disruptions, markets expect higher inflation. These expectations have caused investors to dump bonds and become jittery about sky-high tech and other equities.

Now the hope is that the US Federal Reserve Board will lead a cavalry of central bankers to buy bonds. Previously, when the bond market proved to be vulnerable, central banks moved in to help the markets settle.

Regardless of what central banks do, growth and inflation will be the key to a recovery in bond prices and lower yields.

The global bond market is truly massive. According to the International Capital Markets Association, the overall size of the global bond markets reached US$128.3 trillion at the end of June 2020.

The breakdown was US$87.5 trillion in sovereign supranational and agency (SSA) debt and US$40.9 trillion corporate bonds.

The SSA bond markets are dominated by the US (US$22.4 trillion), China (US$19.8 trillion), and Japan (US$12.4 trillion). Those three nations thus account for 62 per cent of the global SSA market.

Central banks can thus send a firm message to the market but would be virtually powerless if economic forces and sentiment lean against the wind. Australia's attempt to support bond prices last week failed.

So far, the market has also ignored Fed chairman Jerome Powell's reaffirmation that the central bank remains committed to easy money policies until the economy recovers from the pandemic. "The economy is a long way from our employment and inflation goals," he said in testimony to the Senate Banking Committee.

The Fed will therefore continue to support the economy with near-zero interest rates and large-scale asset purchases until "substantial further progress has been made", he added.

When yields rise, bond prices plunge and the longer the period for the repayment of the bond, the greater the decline.

Since its all-time yield low of 0.52 per cent in the middle of last year, a yield jump to almost 1.5 per cent caused the 10-year US Treasury price to tumble by 8 per cent. The price decline of 30-year US Treasuries exceeded 23 per cent and these bonds currently have yields of 2.29 per cent.

Since US Treasuries are by far the biggest market in the world they influence bond prices around the world.

As such, corporate bond yields have risen. And depending on the health of the businesses, the credit risk factor can raise so-called "junk bond" yields to even greater heights.

In his latest Berkshire Hathaway letter, Warren Buffett said that "bonds are not the place to be these days". He noted that 10-year US Treasury bond yields had fallen 94 per cent from a whopping 15.8 per cent yield in September 1981.

"Fixed-income investors worldwide - whether pension funds, insurance companies or retirees - face a bleak future," Mr Buffett said.

"Inflation is picking up across advanced economies and emerging markets, but the data suggests this will again prove temporary," said Tamara Basic Vasiljev of Oxford Economics.

"We see no signs of lasting pressures that might turn a temporary spike into a lasting overshoot. Money velocity has recovered only slightly."

Lacy Hunt, the chief economist at investment adviser Hoisington, takes a "contrary stance" on the grounds that the virus' destruction of wealth, business shutdowns and debt overhang will keep economies depressed.

Therefore, she feels interest rates "will eventually gravitate to lower levels as inflation continues to recede".