Lately the drums have been beating more loudly that a new bear market in bonds is at hand.
The yield on the 10-year Treasury note TMUBMUSD10Y, -1.08% has risen from 2.43% at the beginning of the year (and barely over 2% last August) to around 2.9% now — a big move in a short time for this usually staid asset class. Bond yields move the opposite way from prices, so a big jump in yield like this means a lot of people are selling bonds.
Why? Fear of higher inflation, bonds’ archenemy, and how the Federal Reserve might react. On Tuesday, new Fed Chairman Jerome Powell shook up markets by appearing to hint during Congressional testimony that the central bank might consider four hikes in the federal-funds rate this year rather than the expected three. (In January, I predicted the Fed would hike the fed-funds rate four times in 2018.)
The Dow Jones Industrial Average DJIA, -0.29% lost nearly 300 points Tuesday, while the S&P 500 SPX, +0.51% shed more than 50 points on the day. Both rallied early Wednesday, but ended the session sharply lower.
The bond market’s declines have prompted some high-profile managers like Jeffrey Gundlach of DoubleLine Capital and Bill Gross, formerly of Pimco but now at Janus, to declare the 35-year-long-plus bull market in bonds is over.
That bull market took 10-year Treasury yields from 19.1% in 1981 all the way down to 1.38% in July 2016. Gundlach and Gross argue this spike in yields — they’ve more than doubled since then — breaks the back of the multidecade bullish run. (Craig Johnson, Piper Jaffray’s chief market technician and who predicted the recent stock-market correction, also said a bear market in bonds would kick in at a 10-year yield of 2.6%-2.7%. We’ve been well beyond that for weeks.)
I think all this talk of a “day of reckoning” for bonds is premature. First of all, Gundlach said bonds faced a “moment of truth” when the 10-year Treasury’s yield topped 2.4% last October while Gross declared the bond bull market over back in 2013, 2014 and 2015. Of course, bonds rallied and yields dropped to all-time new lows in the years after the former Bond King’s bearish calls.
Second, 10-year yields topped 3% in December 2013 only to plunge again later. By my reading of the charts, the true breaking point for the bond bull is between 3% and 3.5% — and yields have to stay there for a while for this to become a real bear.
Third, economic growth is picking up, but in 2017 GDP grew by less than 3% a year. GDP growth averaged almost 6% annually during the 1960s boom. So, this economy is far from overheating. That means, as I wrote last week, that we have a long way to go until inflation is a real threat again.
Finally, fear of the Fed is way overblown. Powell may slip in another quarter-point rate increase or two if inflation edges up, but thus far he has shown no indication of breaking with the Bernanke-Yellen orthodoxy. In his five years on the Federal Reserve Board, he never cast a dissenting vote on monetary policy.
I’m still looking for gradual rate increases, an ultimate target of a 3% federal-funds rate by 2020 (it got as high as 5.25% in 2006, before the financial crisis), and — again, that word — gradual reductions in the Fed’s bloated balance sheet over the next few years.
The huge tax cuts and spending bills passed by the GOP-controlled Congress and signed by a Republican president should help stimulate the economy, but will leave trillion-dollar deficits as far as the eye can see. The government’s greater financing needs will push rates higher over time, but I see no spike any time soon.
Pimco, one of the world’s leading bond-fund managers and Gross’s alma mater, has taken the contrarian position that rates won’t move up much more. Mark Kiesel, Pimco’s chief investment officer of global credit, told Bloomberg recently he’d even “consider buying bonds” if the 10-year’s yield hits 3%.
I wouldn’t go that far, because I think in the long run rates are heading higher. But I certainly wouldn’t dump them in a panic, either. Days of reckoning tend to be few and very far between.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.