The bond market has a licence to kill you

Bond markets around the world are selling off, hard. It’s an almost global shift. Yet, in each country, the financial media try to blame local factors.

The Aussie media is hounding the poor Treasurer for his budget blitzkrieg. The Australian Financial Review was unusually judgemental about it:

Yields hit 15-year high as bond investors damn ‘radical budget’

Investors have panned Labor’s budget, dumping 10-year bonds because of their fears spending will stoke inflation and pile debt onto younger generations.

Even if the budget is as bad as Pauline Hanson says, this is unfair. Bond yields are also spiking in places pursuing very different tax policy.

Admittedly, economics can be confusing. The Treasurer’s tax-grab is specifically designed to cut inflation and intergenerational debt. Yet the Australian Financial Review can simply state it’ll do the opposite. In any other field of ‘science,’ you couldn’t have such a blatant disagreement for long.

But the point is that we can’t agree on the basics. So judgemental coverage is a bit presumptuous.

In the UK, the bond yield spike is being blamed on the latest Prime Minister’s short shelf life. Not so long ago, respected journalist Andrew Marr was telling his viewers that Keir Starmer’s Labour government meant that ‘the adults back in the room.’

He has since expressed his regrets…

The UK scenario is especially interesting because it is such an astonishingly accurate reenactment of the 1970s fiscal crisis. It’s as if Margaret Thatcher, James Callaghan and Tony Benn were still alive.

If you don’t know who these politicians are, that’s kind of my point. The Brits have forgotten the lessons they learned the hard way in spectacular fashion. The IMF had to rescue them from a bond market yield surge back then too.

But the Brits were the only ones going through that mess, at the time. This time, it’s a global problem.

In Japan, the bond market already risks causing a global financial crisis. Yields are spiking to dangerous levels considering the amount of debt. But why? Is Jim Chalmers running their budget too?

Strangely enough, Japan’s Prime Minister considers herself a Thatcher protégé while following precisely the opposite economic strategy.

Heck, in Japan they‘re fighting inflation by handing out cash!!!

The Japanese are blaming speculators for the yield spike. And occasionally engineering market interventions to keep their currency from crashing.

But not every country is clueless about the track record of such policies. Yet they’re all facing higher bond yields. So, they must have something in common.

That hasn’t stopped Americans from blaming President Trump for their own bond yield spike.

What’s behind the bond market revolt?

There are several possibilities. The hard part is figuring out which one applies. After all, the bond market is telling you that something has changed radically. Figuring out what could be crucial to how you should be investing.

So, let’s take a closer look at what the bond market is trying to tell you…

Bonds represent a promise to pay a fixed amount of money in the future. If inflation is expected to go up, that money will be worth less by the time you get it. So the government has to offer a higher yield to compensate investors for the inflation.

In other words, the bond market is telling you inflation will rise.

The intriguing thing about this explanation is that oil price shocks are temporary. In fact, they are self-reversing. The higher the price spikes, the more production will come online in the future. The resulting glut will reduce prices.

Of course inflation would never fall below zero as the oil price normalises. Central banks would never allow your cost of living to fall…

But the point is that bond markets shouldn’t move as much as they have because of a temporary blip in inflation. And it’s the long-end of the bond market that’s moved. This implies higher long-term inflation.

Bonds could be pricing in central bank interest rate increases in a panicked and misguided response to the inflation burst. After all, central bankers are too stupid to tell the difference between transitory inflaiton from an energy shock and persistent inflation from printing too much money.

The bond market is betting they’ll get it wrong again. It is anticipating their interest rate increases by allowing yields to rise.

The trouble with this explanation is that it is self-defeating. Central bankers will raise interest rates too far, cause a crisis, and then cut them again. The second half of that story is good news for bonds. They shouldn’t be selling off.

Another possibility is central bank balance sheets. Central banks have been reversing past bond purchases. Quantitative easing was replaced by quantitative tightening.

This raises bond yields because central banks are selling government bonds, or allowing bonds to mature without buying more. Bonds maturing has the same net effect as selling them because new bonds have to be issued to repay the old ones.

The point is that it’s a supply and demand issue in the bond market. One that many countries do actually share.

The final explanation is totally surreal.

The world is about to embark on an AI driven productivity boom. It is going to make the economy grow so fast that our past government debt will be rendered irrelevant.

Why would this make people sell bonds? Because who wants to own bonds when tech stocks are booming?

So, yes, rising bonds yields an be a sign of optimism about the future.

Why do stocks care about bonds?

Bond yields are like gravity to financial markets. Except the power of that gravity can wax and wane.

Higher yields mean better returns for ‘risk-free’ investments. Sitting out of the stock market becomes more acceptable.

Higher yields mean debt costs for companies and other borrowers rise.

And higher yields put pressure on the government budget.

Each of these has a direct bearing on stocks.

So you cannot escape the bond market’s gravity by sitting in stocks.

Although, not every section of the stock market is equally affected. And some trends are powerful enough to defy gravity and fly under their own steam.