The yield to maturity of the most-watched bond ever – the 10-year US Treasury Bond – reached an all-time low of 0.5% in August last year. As the market prices of bonds and bond yields to maturity move in opposite directions – when one rises, the other falls, and vice versa – the market price of this bond reached an all-time high as well in August last year. From this point on, yield to maturity began to grow relatively steeply. At the end of last year, it was 0.9%. At the beginning of this year, the rise of this yield to maturity continued. So far, it has increased by 0.64 percentage point and its current level is 1.55%.
Bond yields to maturity generally began to rise at the end of last year as coronavirus vaccines began to be widely rolled out. As a result, the economic outlook has improved significantly. In addition, key central banks are still conducting quantitative easing – money printing – on an unprecedented scale, and the fiscal policies of major economies are still extremely loose. After all, in the United States, for example, a $ 1.9 trillion fiscal package is currently in the final stages of the approval process. As a result of this monetary and fiscal policy stance and thus the markedly improved economic outlook of the global economy, inflation expectations began to rise sharply. At the same time, they reached 10-year highs in both the USA and the euro area, measured according to inflation swaps. And it is precisely the inflation expectations that bond yields to maturity and thus the market prices of bonds are extremely sensitive to.
I believe that the rise in bond yields to maturity should continue in the coming months because real inflation-adjusted bond yields to maturity are still deeply negative. Until real inflation-adjusted bond yields to maturity return to positive values, the capital of bond-holding investors will continue to decline in real terms. Overall, therefore, I believe that although bond markets have lost 4% since the beginning of the year, according to the broadest global bond index, Bloomberg Barclays Global Aggregate Bond, the bond correction is probably far from over. The risk of this negative bond outlook is, of course, the possibility that key central banks, especially the Fed and the ECB, could choose to implement a yield curve control (YCC), following the example of the Bank of Japan, which in practice would mean explicit targeting of bond yields to maturity and unlimited quantitative easing.
Investment Strategist at Conseq Investment Management, a.s.