Joachim Fels and Manoj Pradhan, part of the group’s global economics team, say a bubble in the bond market is shrinking as valuations come back down. The rise in yields is partly owing to this and partly due to concern over sovereign risk as public sector debt continues to grow, especially in Britain and America.
“To a large extent, we view the rise in bond yields as the unwinding of a bond bubble that inflated late last year,” they say. “Bond yields have not shot up to unsustainable highs, but have rather bounced off unsustainable lows.”
Fels and Pradhan say it is important to remember that the recent sharp sell-off in government bonds is the continuation of a trend that began early this year. “Between mid-November and the end of last year, the 10-year US Treasury yield collapsed from a range of 3.5% to 4% to a low of only 2.05% when it became clear that the global economy was falling off a cliff and deflation fears surged,” they say.
“From the low in late December, yields have now backed up by some 150 basis points to 3.58%, back to the range that prevailed for most of 2008.”
They predict bond yields will drift higher over the medium-term, with 10-year US Treasury yields likely to rise above 5% over the next 12 months.
Meanwhile, central banks’ quantitative easing measures are unlikely to be thrown off course by the sell-off in the government bond markets, Fels and Pradhan say.
“In our view, the major central banks are more likely to see the back-up in bond yields as a sign of normalisation rather than something to worry about. After all, they resorted to unprecedented conventional and unconventional easing in response to the rising deflation threat. The fact that deflation fears have now abated—though not wholly disappeared—is therefore likely to be seen as a success.
“Given the outlook for an only hesitant economic recovery later this year, the bond market sell-off is unlikely to derail the quantitative easing programmes that are currently underway in the US and the UK.”