A $100 (U.S.) bill. Bond prices move in the opposite direction to yields and yields have jumped sharply since the beginning of May, with the payout on the benchmark 10-year U.S. Treasury climbing from around 1.6 per cent to 2.1 per cent.ANDY WONG/The Associated Press
The three-decade-long bull market in bonds may be nearing an end, but don't write its obituary just yet.
Two canny U.S. market watchers – Gary Shilling and Van Hoisington – believe the recent plunge in bond prices is only a temporary pause in the market's long upward move.
"Many people have periodically, and now is no exception, said 'it's over' … but I think you've got to see a change in economic conditions for that to happen," comments Mr. Shilling, founder of A. Gary Shilling & Co. Inc., a New Jersey-based economic consulting firm.
Bond prices move in the opposite direction to yields and yields have jumped sharply since the beginning of May, with the payout on the benchmark 10-year U.S. Treasury climbing from around 1.6 per cent to 2.1 per cent.
While an increase of half a percentage point may not seem like much, it's considered a major move on fixed-income markets and has ripple effects throughout the global economy on everything from mortgage rates to stock prices.
The sudden upward move in yields has some observers speculating that this is the end of a generation-long period in which people have witnessed nothing but falling yields and rising bond prices.
Back in 1981, at the tail end of the disco era, the 10-year U.S. Treasury yielded nearly 16 per cent. Bond investors have done very well since then as yields have consistently declined, sending prices ever higher. But as rates have plunged to historic lows in recent years, many investors have grown skeptical of bonds' potential to deliver further gains.
Among the skeptics is master investor Warren Buffett, who said recently he believes bonds make a terrible buy. GMO, the Boston-based asset management firm, has also gone on record as saying bonds have little appeal.
Mr. Shilling disagrees. Back in 1981, when bonds were little loved because of rampaging inflation, he urged investors to load up on Treasuries, saying they were about to embark on what he predicted would be a "rally of a lifetime." It's a call that has been vindicated, as has his position ever since that investors should maintain a healthy bond exposure.
"I'm not ready to say the bond rally of a lifetime is over," Mr. Shilling said in an interview on Monday.
Mr. Hoisington, head of an eponymously named money management firm based in Texas, concurs. He says that bonds have fallen "for a time every year," only to resume their advance, a pattern he expects to be repeated. He's been bullish for the past two decades, once again a correct call.
The sudden drop in prices and rise in yields has caught some prominent investors by surprise. U.S. money maven Bill Gross, who runs the world's largest bond fund at Pacific Investment Management Co., loaded up on Treasuries, but the price slide cut the value of his holdings last month.
Most market watchers believe bonds have sold off because of fears the U.S. Federal Reserve Board, which has been buying Treasuries and mortgage bonds at the rate of $85-billion (U.S.) a month, may begin to taper off its purchases.
But Mr. Shilling says he doubts the Fed will shift gears any time soon. For one thing, there is almost no inflation, with the year-over-year increase in the consumer price index only around 1 per cent.
Commodity prices are weak, while unemployment remains high, and workers are unable to push for large wage increases – all factors that reduce inflationary pressures and make bonds' dependable payouts relatively attractive. In fact, Mr. Shilling believes that the economy could slip into deflation, another bond-friendly possibility.
For his part, Mr. Hoisington believes that markets shouldn't fear an end to the central bank's bond purchasing program.
He believes that when the Fed buys bonds it causes prices of those securities to fall as private investors dump their holdings to move into other assets because they fear the central bank may be stoking inflation or is being too expansionary in its monetary policy. When the Fed stops buy bonds, these worries subside and yields decline.
"We believe that's true mainly because it will be proven that the Federal Reserve has been unable to engender strong growth or inflation, that they're a toothless tiger," he says.