Evidently, this is the most dangerous bond market in history.
Here’s the logic behind this statement, which was included in a Bloomberg News headline Monday: Yields are so low that the smallest of rate increases would wreak havoc on prices, causing billions of dollars of losses for investors worldwide. Of course, similar warnings have been sounded for years, but yields only dropped further and further, fueling huge bond rallies and fostering deep skepticism about any bond-market warnings.
This time, however, the risk of disruption may be greater for several reasons. The main one arguably is the price of oil.
Crude values tumbled in 2014, leading investors to worry about stagnant global growth and deflation. This helped give steam to the 11.7 percent rally in sovereign bonds globally over the past two years. Since February, however, oil prices have rallied and appear to be stabilizing.
Higher commodity prices don’t necessarily signal faster economic growth. But markets have largely treated crude values as a proxy for economic expansion and inflation over the past two years, regardless of whether that makes any historical sense. When oil gains, so do stocks and higher-risk bonds. When crude drops, investors often are compelled to huddle for safety in government bonds.
U.S. government bonds have lost almost a percentage point since Feb. 11, when oil embarked on a rally that has pushed prices up 39 percent. If oil prices go higher still, investors are going to start worrying less about deflation and more about inflation. That's already happening to some degree, with a gauge of inflation expectations in the U.S. bond market rising to the highest level in nine months on Monday.
And increasingly it seems as though central banks are losing some of their dominance over bond markets. For example, even though the European Central Bank is expanding its monthly asset purchases and maintaining negative deposit rates, yields in less-creditworthy regions, such as Italy and Portugal, have risen.
The Federal Reserve, meanwhile, is planning to raise U.S. benchmark rates further this year, which may edify a sense that growth is generally accelerating in the world's biggest economy.
Perhaps this year's warnings of higher bond yields will be yet another false alarm. This is uncharted territory. Maybe the trillions of dollars of bonds with negative yields will continue to gain value, providing holders with returns.
But there's reason to be cautious before piling into the most-expensive government debt in history at this point.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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