This year was supposed to be different. The sell-off in government bonds seen in the second half of 2016 gave new heft to the recurrent predictions of doom for the asset class. The grand new narrative for investors – the Trump trade of higher inflation and a shift towards cyclical and value stocks – was accompanied by a fresh lease of life for the argument that government bonds’ days are numbered.
Look back to recent Januarys and, on each occasion, there were few market participants forecasting anything other than catastrophe for sovereign debt. The debate sorely needed 2017’s new line of reasoning, given the bears have been comprehensively outdone in recent years.
A few months on, and the situation is starting to look pretty familiar. Doubts have surfaced over the core tenets of the Trump trade - meaningful increases inflation and infrastructure spending - and that has meant the likes of US and UK government bonds have started rallying once again.
Gilt yields have fallen back from 1.47 per cent to 1 per cent since the end of January. Ten-year Treasury yields, at 2.22 per cent, are back below where they were at the start of last year. The long-anticipated tightening of monetary policy in the US has had little impact, despite March’s hike being far from priced in at the start of the year.
The debate over whether the world is still in a debt-deflation environment may have become more nuanced, but the other drivers of high bond prices – ageing demographics and structural demand from institutional investors – are superseding the valuation argument again.
For fund buyers and intermediaries, not in the business of trading positions on a short-term basis, it’s tough to contemplate. The logic of government bonds looking unattractive on a long-term time horizon is hard to overcome.
The risk-reward equation also complicates things: now sovereign debt is no longer a low-risk asset, what kind of role can it play in a portfolio?
The answer, Vanguard suggests elsewhere in these pages, is diversification. In the US, at least, equity and bond correlations remain near record lows, a fact which “offsets the lower-than-expected returns on government bonds”, according to the firm.
The problem with this argument is that market participants have been burned so badly by 2013’s taper tantrum. Not so much the extent of that simultaneous bond and equity sell-off, but by the possibility that this kind of unusual event could become more common.
This nervousness stems from the fact that no one quite knows how the unwinding of extraordinary monetary policy will play out. But one thing is certain: the trends that have powered the bond market for the past three decades or more are proving hard to shake.
Dan Jones is editor of Investment Adviser