Don't Fear the Bond Reaper

The rout signals rates can't turn endlessly negative after all. That's positive.

Global bonds are finishing up their worst monthly performance in six years, which is remarkable after many months of hefty, steady gains.

Even more remarkable is that no one can really come up with a definitive narrative for why the market has turned to a losing streak, culminating in a 3 percent loss for October. The Wall Street Journal painted the latest dip as overdue, a relief to many investors who've been patiently waiting for just such a selloff. A Bloomberg story attributed to the rout to questions about the efficacy of central-bank stimulus.

October Chill

Global bonds have posted their worst monthly loss in October since 2010

Source: Bloomberg Barclays bond indexes

Some blame rising inflation expectations in the U.K. and a generally improving U.S. economy, while others point to a glut of debt sales. These reasons tend to work against one another rather than mesh into one, cohesive explanation, noted Peter Atwater, president of Financial Insyghts.

Regardless of the exact reason, the selloff sends an important message. It signals that yields can't turn endlessly negative after all, especially without a serious economic downturn.

This is a marked shift from earlier in the year, when investors seemed to be buying bonds just because they weren't sure what else to do with themselves. The vortex of negative-yielding debt kept expanding. Analysts talked of deflation and helicopter money.

Bond Blip

While global bonds have sold off this month, yields are still historically very low

Source: Bloomberg Barclays Global Aggregate bond index

Now, however, central bankers in Europe and Japan are facing a shortage of eligible securities for their planned asset-purchase programs. Japan, for its part, seems to have recognized the harmful effects its stimulus is having on financial institutions, and is aiming to tightly control the yield curve now rather than simply pushing borrowing costs ever lower. Europe's program, meanwhile, is fast approaching the end of its stated run. While central bankers are widely expected to extend it, they'll likely talk about tapering the amount of debt they buy each month.

Meanwhile, Britain is finally getting inflation, which has been the holy grail of policy makers in the past few years. The only problem is that it's happening too fast, and comes as a result of the nation's vote to exit the European Union and the subsequent rapid depreciation of the pound, rather than a strengthening economy. While this may eventually turn into a positive for the U.K., right now it seems more problematic than encouraging. 

Given all this uncertainty (and a bunch more given elections from the U.S. to Italy), investors would rather own cash than hold bonds at such low yields.  Fund managers have raised their cash balances to 5.8 percent of their portfolios this month, the equal highest level since November 2001, according to a Bank of America Merrill Lynch survey of money managers.

The average yield on the Bloomberg Barclays Global Aggregate Index has risen to 1.3 percent from 1.07 percent in July.

While this move has resulted in steep mark-to-market losses for some bond portfolios, it's a positive development.  The rules of investing haven't all been thrown out the window. There's a limit to how low bond yields can go. The October buyers' strike suggests the market has started to find that floor.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lisa Abramowicz in New York at

    To contact the editor responsible for this story:
    Matthew Brooker at

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