Global market overview - Return of the bond vigilantes?
A sharp rise in bond yields dominated investors’ attention in October. The magnitude of the move will no doubt leave many wondering whether fixed income’s long bull run might be reversing, a concern that has started to cloud the prospects for financial markets more generally.
Global bonds – as measured by the Barclays Global Aggregate Index – posted a loss of more than 3 per cent on the month in US dollar terms, with UK sovereign debt dropping 10 per cent – though this was in part down to dollar strength. In local currency terms, global bonds overall lost around 1.5 per cent, while UK gilts were down about 4 per cent. Driving the bond market shakeout is the worry that central banks will start turning off the liquidity taps in the face of steady economic growth and rising inflation. Indeed, the US 5y5y breakeven yield – a gauge of investors' long-term inflation projections – moved up to 1.9 per cent, its highest level since the end of 2015. A variety of factors are behind building price pressures from purely technical base effects – favourable year-on-year comparatives are dropping out of the data – to more fundamental forces.To begin with, a pick-up in commodity prices following their slump at the start of the year has started to filter through to consumers. Oil prices climbed back above USD50 a barrel from lows below USD30 earlier in the year. In all, they have risen more than a fifth since the start of the year, while commodities overall are up more than 7 per cent.
But the primary force driving inflation expectations appears to be the likely elimination of the US’s output gap. With weekly jobless claims falling to lows not seen since the early 1970s, the signs are that wage pressures could intensify. The probability of a US Federal Reserve rate rise in December has risen above 70 per cent and there are expectations for two further hikes in 2017.
Stocks have, so far, taken the bond market moves with surprising equanimity. Global equities were largely flat in local currency terms on the month, though there was increasing dispersion between sectors. Cyclical stocks fared the best, with energy, materials and financials managing gains in local currency terms and consumer discretionary edging back only slightly. Meanwhile, some of the biggest losers were defensive sectors, which tend to be closely correlated with bonds, including staples and health care.