Bears in the Bond Market

If certain high profile fund managers and bond investors are to be believed, then the bond market has just slipped into a bear market. They are not talking about the usual tightening of the Fed’s interest rates.

Interest rates have risen several times over the past few years. However, every time they return to normal.

This time, seasoned bond traders are of the opinion that the bond yields will rise permanently. This means that the yields will not return to lower levels any time soon.

The bond market was at the peak of a bear run in 1981. During that time, the bond yields had peaked at 21%.

Later, the yields have been systematically reduced for the past 35 years.

However, the present hike in interest rates seems to be the beginning of a new bear run, one that could continue for decades just like the “Bull Run” preceding it. The fears of bond investors are being further sparked by the fact that the government has been trying to keep the “Bull Run” alive by artificial methods!

In this article, we will explore the possibility of a sustained bear run in the bond markets. The points for and against this argument are being discussed in this article.

Reasons for the Bear Market

There is widespread skepticism that a full-fledged bear market has already begun. Some common reasons given for the same are as follows:

  • Generational Low in Interest Rates: As already mentioned above, the bond market has been in a bull run for more than 35 years. This means that the government has been artificially lowering interest rates.

    Since interest rates move in the opposite direction to bond prices, this has created a rally in the bond markets.

    Experts in the field are of the opinion that bond rates have bottomed out in 2016.

    The Fed has been increasing the interest rates since 2016. However, the increases have been very slow and gradual.

    In the forthcoming years, the interest rate hike is likely to pick up speed. At present, the interest rates on US treasuries are below 3%. They are expected to rise to at least 5% which has been the historical average.

    Since the interest rates will double, it is expected that the bond values will fall drastically. Hence, the fears of a bear market.

  • Fiscal Stimulus May Cause Inflation: The economies of many countries are in jeopardy. Even rapidly advancing countries like China have a lot of debt.

    As a result, it is likely that the rising interest rates will cause some of these economies to go into turmoil.

    In the past, central banks have been lowering interest rates at the sign of any financial distress.

    However, now they may not be able to do so. This is because huge fiscal stimulus packages will already have an inflationary effect. If interest rates are lowered further, it could cause runaway inflation. Hence interest rates are likely to remain on the higher side.

Reasons Against the Bear Market

Many investors believe that the fear of the bear market has been exaggerated. This could be a tactic being used by fund managers to make the prices drop and they buy bonds at cheap prices. The following reasons explain why it is unlikely that the bond market will face a sustained crash.

  • Incorrect Analysis: The basis for this bear market prediction is the fact that interest rates have shown an upward trend in the past few months. The analysts believe that the bull market trend has been broken and hence bear run is about to begin.

    Firstly, 3% is an important benchmark to gauge whether or not the bond market is in a bear trap. At the present moment, the yields are below 3%.

    Hence, there is no question of the market being in a bear trap as of now. It would be incorrect to simply extrapolate the past hikes to believe that the rates will continue rising in the future. The so called “experts” are extrapolating a minor trend to predict a long term trend spanning years and are making doom and gloom prediction based on that trend.

  • Government Needs to Borrow: One of the biggest reasons that the interest rates might not go up much is because the government needs to borrow.

    Donald Trump’s tax cuts will lead to reduced revenue. However, at the same time, the expenses are not going down.

    Hence, the United States government will be forced to borrow more money.

    If the interest rates rise considerably, the government may have to shell out a lot more in the form of interest payments.

    Since the government would not want the interest rates to impact its already fragile budget, the odds are that the government will keep the interest rates under control for its own benefit.

  • Inflation Isn’t Really a Threat: The Fed is only forced to raise interest rates if the inflation rate is increasing at an alarming speed.

    However, that is not the case with United States as of now. The inflation rate is under control at 2% and shows no sign of suddenly increasing.

    Hence, the likelihood of a sustained bear market does not seem likely given the information at hand.

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