There is a very good reason, comments one bond fund manager, that yield curves slope upwards. And now, once again, they are.
But, explain Michael Mackenzie and John Authers in the FT, the rise in bond yields last week reflected more than a short-term reversal, or a sell-off in the mould seen back in 1994 or 2003. Last week’s sell-off wasn’t prompted by an inflation scare, or unexpected shift in interest rates - and unlike on previous occasions, the spike in yields broke out of a downward trend that had persisted since 1987, with yields peaking at progressively lower points in successive cycles.
The bond market, say Mackenzie and Authers, seems to have suddenly snapped out of its years of complacency without a specific trigger. That raises the prospect that the era of cheap financing is coming to an end, with the holders of riskier assets, corporate credit and emerging market debt, next up to ditch their sanguine view of risk.
A further question, adds Tony Jackson in his Monday column, is what impact the rising Treasury yields might have on equities. One argument runs that if people (read China) are buying less bonds, they must be buying equities - a bullish signal.
But, says Jackson, that runs counter to the notion of an equity risk premium. If bond yields rise, the required return on equities does also, suggesting equities should fall.
The notion of an equity risk premium has fallen out of favour of late, he adds. The correlation between bond and equity returns in the past few years has been more negative than at any time in the past century - there have been an abnormal number of months in which they have gone in opposite directions. Equities have massively outperformed bonds, so the risk premium over the period looks very high.
But might investors have realised at the outset that the backdrop for equities was benign and required a lower premium going forwards, paying higher prices for equities and generating higher returns?
Plus, says Jackson, we have no clear idea whether bond prices should in theory determine equity prices or vice versa.
But if the next act involves widening of credit spreads from their present abnormal tightness, worse returns for private equity and an end to the run of zero defaults in the corporate sector, the equity risk premium might indeed start to rise again.
What do rising bond yields mean for equities? The answer, unapologetically says Jackson, is that we don’t know.
