Following a new script
Bonds are proving unexpectedly popular so far this year
Jan 18th 2014
THE advance billing for government bonds in 2014 was that they would be shunned by investors, hopeful for higher returns in equities and fearful of monetary-policy tightening as America’s central bank started to phase out its bond-purchasing programme. That may still turn out to be the case, especially if the recovery flourishes. But the first reel of the show has not conformed with those expectations. Bond markets have fared surprisingly well.
Instead of rising since the end of 2013, yields on benchmark ten-year bonds, which are inversely related to prices, have fallen in America and Europe (see chart). Yields on US Treasuries have slipped from 3.01% to 2.88%; on British gilts from 3.03% to 2.86%; and on German bunds from 1.94% to 1.83%. Yields on emerging-market sovereign debt have been spared the rise many were fearing.
Some bond markets in the once ostracised periphery of the euro area have done particularly well. In Portugal, which needed a bail-out programme in mid-2011, yields have dropped from 6.2% at the end of 2013 to 5.3%. This steep fall was helped by a successful sale of five-year debt on January 9th, which raised €3.25 billion ($4.4 billion) in an issue that attracted total orders of over €11 billion. Two days earlier a sale of Irish ten-year bonds was also heavily oversubscribed.
The good start reflects factors that are specific to America and to Europe as well as common influences. American bond yields, which set the tone for global markets, had already risen a long way since last summer when the Federal Reserve first mooted “tapering” its $85 billion-a-month asset-purchasing programme. That sent a shock rippling round the world that was felt most of all in emerging markets, where yields surged. The Fed’s failure to start the taper in September, as many observers had expected, brought temporary respite. But after the Fed’s decision on December 18th to lower this month’s purchases to $75 billion, ten-year US bond yields had risen from around 1.6% at the start of May to 3% by the end of 2013.
Signs of a burgeoning American recovery underpinned both the rise in yields on US Treasuries and the Fed’s decision last month to start tapering. But disappointing jobs figures released on January 10th punctured the increasingly optimistic mood. Economists had expected employers to add around 200,000 jobs in December; the actual number was a lowly 74,000.
The unemployment rate, based on a separate household survey, fell from 7% to 6.7%, but this was largely because of people dropping out of the labour force, which at 62.8% of the adult population has slipped back to where it stood in October, the lowest level since 1978.
The poor jobs figures may be an aberration, caused by unusually cold weather last month. But they were enough to prompt traders to wonder whether the Fed might be more cautious than they had imagined in phasing out its asset purchases, let alone in raising interest rates. That unemployment has now fallen close to the 6.5% threshold at which the Fed had previously said it might start raising rates no longer matters. In December it said that it would keep its benchmark rate at its current low “well past the time” the unemployment rate falls below 6.5%.
Another reason for a rethink about bond markets is low inflation. In America the price index targeted by the Fed (which aims at 2% inflation) has been rising by less than 1%. In Britain consumer-price figures published on January 14th showed inflation hitting the Bank of England’s 2% target, after four years above it. The fillip to bond markets from low inflation is stronger still in the euro zone, where consumer prices rose by just 0.8% in the year to December and core inflation (stripping out volatile items like energy and food) fell to a record low of 0.7%.
An environment where the risk is of deflation rather than inflation is proving a potent incentive for some investors to take a punt on bonds in southern Europe. Dismal sovereign credit ratings will remain a barrier, although these typically lag behind the markets. High government and external debt will continue to deter the more cautious. Nonetheless, Portuguese bond yields, which for most of the past four years have been much higher than those for emerging markets, are now at parity with them.
The gains in bond markets have contrasted with a setback in equities in the first half of January.
Global stockmarkets have fallen by 0.3%, with America’s S&P 500 taking a particular tumble on January 13th, when it fell by 1.3%. Investors who fear that last year’s spectacular rally went too far may have started to reconsider where to put their money.
Plenty could yet go wrong for bond investors this year. Market historians point to 1994, when an unexpected tightening in American monetary policy led to a disastrous surge in yields. But the Fed has put so much weight on its “forward guidance” that such a lurch seems unlikely. If inflation remains low in the developed world and the recovery does not accelerate wildly, 2014 may live up to its benign beginnings for bonds.