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Summary of Document: "Has a Bond Bear Market Begun?"

Core Content

The document explores whether the US bond market is entering a bear market following a multi-decade bull run, with insights from several financial experts. It also provides macroeconomic analysis for the US, Europe, Japan, and Emerging Markets (EM), along with implications for asset classes such as equities, corporate bonds, and EM assets in a rising rate environment.

Main Views on the Bond Bear Market

Paul Tudor Jones (Tudor Investment Corporation)

• YES, a bond bear market has begun.
• Attributes the bear market to a bull market in monetary and fiscal laxity.
• Believes the Fed's prolonged easing has led to a "magical" 2% inflation target, which has suppressed real interest rates.
• Warns of financial bubbles created by low rates and fiscal stimulus.
• Predicts 10-year Treasury yields to rise to 3.75% by year-end, and possibly higher.
• Advocates for holding commodities, hard assets, and cash rather than bonds or equities.
• Notes that central banks have been behind the curve in addressing inflation and financial stability.
• Believes that the Fed should act symmetrically to reverse its policy, not just react to inflation.

Francesco Garzarelli & Scott Rofey (Goldman Sachs)

• Not yet, but a true bear market is unlikely in the near term.
• Expect moderate increases in 10-year yields, around 3.25% and 3.10–3.15% by end-2018.
• Believe the market is mispricing inflation overshoot risk.
• Suggest steepening the yield curve and positioning for a more gradual rate increase in the future.
• Think rate cuts are more likely in the next cycle than further asset purchases.

Gregory Peters (PGIM Fixed Income)

• Far from a bear market, with expectations of declining yields.
• Sees secular disinflationary forces (e.g., demographics, debt burden) as key factors that will cap inflation.
• Predicts 10-year yields to fall to 2.75–2.50% by year-end.
• If the Fed continues to hike rates through 2019, yields could be even lower, and the yield curve may flatten or invert.
• Recommends long positions across the curve, except for the short end.

Key Economic Insights

US

• 10-year Treasury yields are at their highest in years, driven by Fed policy, inflation, and increased supply.
• Core PCE forecast for end-2018 was raised by 0.1pp to 1.9%.
• Rate hike odds for March increased to >95%.
• The federal deficit is expected to reach 5.2% of GDP by 2019, a significant shift from past norms.
• Inflation expectations are rising, but the market remains well-anchored.
• Fiscal policy is seen as a major driver of inflation and financial instability.
• Pension fund behavior is pro-cyclical, potentially exacerbating bond market pressure.

Europe

• UK GDP forecast increased by 0.4pp to 1.7% yoy.
• Euro area GDP forecast increased by 0.1pp to 2.6% yoy.
• Euro area business sentiment remains strong despite a weakening credit impulse.
• BOE rate hikes are expected in May and November 2018.
• Italy's election suggests low odds for meaningful fiscal reform.

Japan

• Policy continuity with Haruhiko Kuroda reappointed and two reflationist deputies.
• Shunto wage negotiations are expected to result in a 2.3% yoy wage increase, but basic wages are likely to rise only 0.5–0.6%.
• Higher oil prices pose a significant risk to the Japanese economy.
• BOJ may continue to support the economy through monetary easing.

Emerging Markets (EM)

• Structural reforms and fiscal consolidation are expected in South Africa under President Ramaphosa.
• China's services activity and exports are strong, helping to stabilize EM economies.
• NAFTA talks and political uncertainty are weighing on Mexico, but the global trade outlook remains strong, albeit volatile.

Impact on Risk Assets

• Equities should remain resilient if rates rise gradually and growth stays strong.
• Corporate bonds and EM assets are also expected to perform well under similar conditions.
• However, if real yields drive the rate increase, equity/bond correlations may turn more positive, leading to double drawdowns.
• Historical examples show that equities can outperform bonds during bond bear markets if growth is robust.
• The 1970s stagflation and early 1940s were notable exceptions where both assets suffered.

Multi-Asset Portfolios and Bond Bear Market

• Bond bear markets can be more damaging to portfolio returns than equity bear markets.
• 60/40 portfolios took years to recover from bond bear markets, such as the 1970s.
• Duration risk is higher today, meaning bond losses could be more severe for the same yield move.

Stress Test for Higher Rates

• GS economists Daan Struyven and Jan Hatzius warn that too fast a rate rise could lead to GDP growth slowdowns, particularly in housing and small business.
• Even if 10-year yields reach 4.5%, a recession is unlikely, but certain sectors will be affected.
• The base case remains a gradual rise in yields, which the economy and markets can handle.

Conclusion

• There is divergence in expert opinions on whether a bond bear market has begun.
• While some believe it is already underway, others see it as not yet and expect moderate yield increases.
• The Fed's role in managing inflation and financial stability is critical.
• Multi-asset portfolios must be mindful of bond duration risk and equity/bond correlations in a rising rate environment.