Key Points

  • Bond yields in major countries have rebounded after plummeting to all-time lows in recent weeks, leading some to conclude that the bond bull market is over.
  • However, the end of the bull market doesn't mean a bear market is starting, as slow global growth, deflationary pressures abroad, a firm dollar and demographic trends are likely to keep yields low.
  • Investors should focus less on short-term changes in the market and more on structuring a fixed income portfolio that can work for them over the long run.

The bull market in U.S. Treasuries looks set to mark its 35th anniversary this fall—assuming it continues. It has been a good run, with investors enjoying attractive returns from their bond portfolios over the years. Ten-year U.S. Treasury yields peaked at 15.84% on September 30, 1981 and fell to a modern-era low of 1.36% on July 8, 2016. (Remember, falling yields reflect rising prices.)

But yields have since bounced back, rising to 1.59% in mid-July. Is this a sign the bull market has run its course? Pundits have repeatedly declared the end of the bond bull market over the years, but, to paraphrase Mark Twain, news of its death has always been premature.

Ten-year Treasury yields, 1970-present

We're not willing to declare the bond bull market over, but we will concede that the recent drop in Treasury yields looked overdone in light of the solid U.S. economic data reported over the past few months. Looking at the U.S. economy in isolation, one would expect investors to be more sanguine. Economic growth is running at a steady 2.0% to 2.5% pace, and inflation is edging higher. Excluding volatile food and energy components, inflation is already above the Federal Reserve's 2% target by some measures. The unemployment rate—at less than 5%—is near where most economists believe the "full 'employment" threshold lies and wages are edging higher for most workers.
Normally, yields fall when the outlook for the economy is uncertain. There is little in the data cited above to support the recent drop.
Moreover, the market probably went too far in reducing expectations for the pace of rate hikes by the Fed. In the immediate aftermath of Britain's vote in June to leave the European Union—better known as the Brexit vote—market expectations for an increase in the federal funds rate this year fell to just 15%. They have since rebounded above a 40% likelihood of a rate hike, which seems more realistic to us.
Implied probability of a Fed rate hike

Why bond yields will likely stay low

However, bond yields are determined in the global market, and forces outside the U.S. are likely to keep U.S. bond yields low, in our view. The market may have overreacted to the actual Brexit vote, but the specter of rising nationalism and a potential increase in trade barriers suggested by the vote also exacerbated long-standing concerns about global growth. Global trade volumes have fallen to half their long-term historical level in recent years. Since trade is highly correlated with global growth, any indications that the free movement of goods, labor or capital across borders might slow tend to stoke concerns about the global economy.

Gross Domestic Product (GDP) versus Trade Volume – World

Consequently, central banks around the globe have been easing monetary policies by pushing short-term interest rates to historically low or even negative levels and expanding bond buying programs. The Bank of England has already indicated it is likely to cut rates in August due to the negative impact that the "Brexit" vote is expected to have on its economy. The European Central Bank has pushed short-term interest rates into negative territory and expanded its bond-buying program to include corporate bonds. The Bank of Japan is even said to be moving toward dropping "helicopter money" to stimulate its economy. (Helicopter money refers to a concept originating with economist Milton Friedman, whereby the central bank provides money directly to citizens—as if dropping it from a helicopter—in order to increase spending and prevent deflation. In practice it is likely to take the form of the government issuing perpetual debt.) With major central banks already holding large portions of outstanding government bonds on their balance sheets, the potential for higher bond yields appears limited, in our view.