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Have we reached the end of the great bond bull run?

28 February 2018

Nordea Asset Management's Witold Bahrke considers whether the 30-year bull bond market has reached an end or whether there is further room to run.

By Witold Bahrke,

Nordea Asset Management

The price of US Treasuries — ‘the mother of all assets’— is often seen as the most important price anchor in the global financial system, carrying a lot of information about markets and the economy.

A reversal in the multi-decade down trend in interest rates would mean a regime shift for markets and the economy, which in some people’s view have become addicted to ever falling interest rates. After a strong rise for government bonds yields recently, are we now at this point?

While volatility in bond markets is expected to rise, we do not think the recent market development marks a major trend reversal. The effect of ‘Trumponomics’ on US Treasuries as such implies higher yields in the coming months, as the positives from tax cuts on the economy and earnings are front loaded and inflation is set to tick up a bit further. A near-term pick-up in inflation, as a lagged response to the cyclical recovery, also points towards higher rates near term.

More medium term, we see no regime shift yet away from the structural ‘lowflation’ environment. Therefore, there are limits to how much core interest rates should rise. A structural rise in inflation requires sustained wage growth.

Very low unemployment has not driven wage inflation higher in recent years. If wage inflation is not rising now – with unemployment in the US hitting the lowest level since the dotcom bubble burst – then when will it?

A key factor currently holding back wages is the fact baby boomers make up a large part of the US labour market. This group typically has high, but relatively constant, salaries.

Once this working generation has retired, wage inflation should increase, as younger people face steeper wage curves. Nevertheless, we think this is a longer-term story, unlikely to affect inflation and interest rates over the coming 6-12 months.

The self-correcting element to yield levels

Parts of the fixed income market seem to agree that the current uptick in inflation is more cyclical than structural, as the market-based long-term inflation expectations are not moving much compared to short-term inflation expectations. This means the current rise in nominal yields pushes up implied real yields —and real yields matter for real growth.


The rise in real yields leads to monetary headwinds, which results in slowing growth, although this normally happens with a time lag. The rise in yields, therefore, should have a self-correcting element to it.

The economy is simply not ready to cope with significantly higher interest rates amid high leverage in most regions.

Importantly, the withdrawal of quantitative easing at the Federal Reserve does not contradict this. Although the Fed started reducing its balance sheet, the US term premium decreased. This has challenged the widely held view central banks in isolation have manipulated the price of the mother of all assets significantly higher via a lower-term premium. In our view, the term premium is low because investors view the risk of disinflation being higher than the risk of higher inflation. As long as this is the case, central banks changing course does not spell doom for bonds.

No death knell for core sovereign debt

In summary, we do not think this is the end of days for core government bonds as an asset class. Any significant weakness will be temporary and not the reversal of the multi-year bull market.

Although rates could rise further in the coming months, we are likely to see lower rates still before entering a sustained upward trend, probably with a US recession in between.

The risk to this view is that the Trump administration’s tax cuts finally create broad-based wage increases in an economy that arguably runs at full capacity.

This would increase inflation and therefore corporate input costs, making margins turn down and incentivising the Fed to tighten even more forcefully. It would neutralise the positive growth effects from tax cuts relatively quickly – a boom/bust scenario, in other words, resulting in a brutal rate rise and some kind of stagflation.

Witold Bahrke is a senior macro strategist at Nordea Asset Management. The views expressed above are his own and should not be taken as investment advice.

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