I can spot a trend when I see one

 From Jesse Felder

Albert Edwards: “A slow-motion crisis is unfolding in the government bond markets that equity investors continue to ignore at their peril.” www.marketwatch.com/story/theres...

Government bonds almost always get repaid.  But shares can go bankrupt, or their prices can halve, or they can suspend dividends.  Bond prices can also fluctuate, even though the payment at the end of their term is guaranteed.   All the same, if you wish to avoid a realised capital loss, you can just hold your bonds to maturity, when you will be paid out in full.  What this means is that if bond yields are drifting higher, then you would expect dividend, or earnings, yields to also be increasing.  Which would, ceteris paribus, reduce share prices.  Yet share prices keep on rising, and earnings/dividend yields keep on falling.  Which is inconsistent, unless economic growth is going to be high.   And I think that's probably unlikely.

US & world bond yields

 I showed a chart of world bond yields here.  This chart shows the average for world bond yields, weighted by their PPP GDP, and covering countries which together make up 83% of world GDP, and is compared with the US 10-year bond yield.  The US makes up ~22% of world GDP.  I have excluded Argentina and Turkey from the calculation of world bond yields, because their inflation rates (and therefore bond yields) are so high they would distort the picture.  However, Russia is included, and its bond yield has risen substantially since the invasion of Ukraine, for obvious reasons.

Note how the world average has in the past been above the US yield, and how for the first time in decades, is now about the same --- including Russia --- as bond markets adjust to raised US inflation and bond issuance risks.

The conclusions from my previous piece are unchanged:  at this stage in the cycle, bond yields should be falling.  And they are not.

Bond yields continue to rise

 Normally, at this stage of the cycle, bond yields would be falling, and they aren't.  Why?  For two reasons.  One, Trump's tariffs and his deportation of migrants will drive up inflation in the USA, which will inhibit the Fed from cutting the fed funds rate in the short term.  And maybe longer term too.  The second is also Trump's fault.  The bond market is very wary of his tax cuts for billionaires.  This will cause the US deficit to balloon.  The Republicans plan to increase the debt ceiling by an incredible 4 TRILLION dollars.   

Note that the 25-year downtrend in yields, which underpinned advances in the stock market and property, has been decisively broken.

World bond yields reach post-covid high

 The GDP-weighted world 10 year bond yield has moved to new post-covid highs, even though the USA's haven't yet.  This reflects rises in a number of developing countries and smaller European and Asian countries such as Poland, Portugal, Taiwan, and South Korea.  In most countries, the rises in bond yields are the result of actual or impending discount rate rises as economies recover from the covid crash.  

 

Interest rates since 1350

From Visual Capitalist

Bond bull market over

The charts below show a clear technical break out of the downtrend that's been in place since the beginning of the bond bull market a year ago. (Remember, the price of a bond is inverse to its yield, so if bond yields are rising it means their prices are falling).

See how, while yields were falling the "rallies" (with respect to yield) took the yield back to the short-term moving average, not through it.  Then in September, the yield breaks up through the 50 day moving average, falls back, but the fall in yield doesn't take yield back to the early September low before it rebounds.  A pattern of rising highs and lows emerges.  Shortly after that, the short-term moving average of the yield starts to rise. 

It's possible that this is a bear-market rally (i.r.o the yield) since the 120 day moving average is still falling.  If this is just a short-lived bounce in yields, the market is saying that it expects growth to slow again.  Which will be very interesting because of its implications for policy and equities.

10 year Oz bonds have fallen (in price) in line with Treasuries, because of a contamination effect, mostly.  The Oz economy continues to slide, so there's no good domestic reason for rising bond yields. 

The recovery in the Germany and the European economy look very sluggish too, so I am surprised at the strength of the sell-off in bonds.  But again, treasury yields tend to drive most developed country bond yields, and even though spreads my widen or narrow (or even invert), they tend not to move so much that they alter turning points.  Having said that, the Treasury/Oz bond yield has gone from a point where Ozzie bonds yielded more than Treasuries to one where they now yield less, reflecting deteriorating growth and falling inflation expectations in Australia.

2019 US recession?

The yield spread--the difference between the yield on 10 year treasury bonds and 2 year bonds--is a sort of guide to economic conditions 2 years down the line.  It's not perfect.  For example, the yield spread (the green line in the chart above) forecast a slowdown in 1997-1999, but the actual recession only came at the end of 2000.  It forecast a much stronger recovery in 2008-2012 after the GFC than in fact happened (although after very deep recessions, the economy's response to stimulatory measures is much weaker and slower than after shallow recessions, because of the negative effects of the loss of confidence.  You can't "push on a string".)

Now it's forecasting a slowdown, at the minimum.  Yet GDP growth is accelerating.  Part of that acceleration is due fiscal stimulus ( the result of Trump's massive tax cuts) and part is due to the strengthening recovery in the rest of the world.  Plus, there is not a perfect fit between the yield spread and growth.  Other forces play a part in expanding or contracting growth.

The rising Fed Funds rate is also pointing towards a slowdown.  The chart shows that 12 month change in the Fed Funds rate, inverted (because rising interest rates lead to falling growth and vice versa) Notice how the 1997-1999 aberration between the yield spread and growth is explicable as a result of moves in the Fed Funds rate.  The rising Fed Funds rate (i.e., shown as declining in the chart below) points towards an imminent US slowdown.  This will be exacerbated as the effects of fiscal stimulus fade.  And it will be worsened by a trade war.  A recession in 2019 seems increasingly plausible.

➥(I forgot to put into the second chart that the Fed Funds rate has been plotted with a 21 months lag, just as the yield spread has)

Treasury sell off

It's tempting to believe that if bonds are selling off, so should equities.  But it depends why they are being sold.  If, for example, they're being sold because the government is in strife, currency is fleeing the country, etc, then both markets should sell off together.  But if they are selling off because bond yields (remember, a rise in yield = a fall in price; the chart on the left shows the yield on 10 year US Treasury bonds) are reverting to "normal" because the risk of recession has diminished, then bonds may sell off while equities advance.

The ending of QE (quantitative easing) exacerbates this dynamic.  QE was introduced to prevent depression, which duly happened, and now that the economy is once again on a path of sustained growth, QE is no longer needed.  Since QE involved the Fed buying long-dated bonds, the phased withdrawal ("tapering") of this massive buyer has inevitably led to a bond sell off.

There is a risk for shares, and that is that the rise fixed rate mortgages as a response to the rise bond yields will cause the economy to slow, since housing is such a significant swing factor.  One to watch, for us and the Fed.

Treasuries selling off

T-Bond yields have bottomed, a major technical reversal.  The markets believe that eco recovery is safe, and that at some point the big buyer of bonds, the Fed, will (at best) stop buying.

Note succession of higher highs and lows, and death cross (since this is the yield, and the price falls as yield rises) where short-term MAV crosses the longer-term one.

Wouldn't be buying bonds now.