The Bond Bear Market of 2018 Never Really Came

(Bloomberg Opinion) -- Remember this?

“Bond bear market confirmed.”

Bill Gross, on Twitter, Jan. 9, 2018

That proclamation, mere days into the New Year, set the tone for the $15.6 trillion U.S. Treasury market in 2018. Not only was it the subject of the most-read article of the year on the Bloomberg terminal among U.S. rates and foreign-exchange news, but it ushered in a new shorthand for projections of higher yields. Later in January, Bridgewater Associates founder Ray Dalio said the bond market had slipped into a bear phase. “A 1 percent rise in bond yields will produce the largest bear market in bonds that we have seen since 1980 to 1981,” he said.

It’s true, things were looking gloomy for the world’s biggest bond market in January. The benchmark 10-year Treasury yield started 2018 at about 2.4 percent, and yet by Feb. 1 had climbed all the way to 2.79 percent in one of the steepest monthly increases of the post-crisis era. It broke through 3 percent in April, spurring Franklin Templeton bond chief Michael Hasenstab to predict “a perfect storm” would push the yield to 4 percent. JPMorgan Chase & Co. CEO Jamie Dimon said in August that investors “better be prepared to deal with rates 5 percent or higher — it’s a higher probability than most people think.” 

As it turns out, the 10-year yield looks as if it will end 2018 right where it ended January. That equates to an annual loss of 0.5 percent for those who held 10-year notes throughout the year, which hardly seems to qualify as a bear market, especially after some U.S. stock indexes tumbled more than 20 percent from their peaks lately. Treasuries with two-, five- and seven-year maturities all posted gains for the year, even as the Federal Reserve raised short-term interest rates four times. The Bloomberg Barclays U.S. Treasury index has a firmly positive year-to-date total return.

To some, this is a surprising outcome for 2018. Others saw it coming. For reference, I went back to my article in June for Bloomberg Markets magazine, appropriately titled “Why a Treasuries Bear Market May Not Live Up to the Hype.” Two quotations stand out as particularly prescient, given recent market moves. Here’s the first from Van Hoisington and Lacy Hunt, who oversee the Wasatch-Hoisington U.S. Treasury Fund:

“No matter how U.S., Japanese, Chinese, European, or emerging-market debt is financed or owned, and regardless of the economic system, the path is stagnation and then decline,” they wrote. “High-quality yields may be difficult to obtain within the next decade.” In the near term, they said, “restrictive monetary policy will bring about lower long-term interest rates.”

Wouldn’t you know it? On Dec. 28, Japan’s 10-year bond yield fell below zero for the first time since 2017. Germany’s 10-year yield, at 0.25 percent, is also near its 2018 low after reaching as high as 0.8 percent in February. And 30-year Treasuries, a favorite of Hoisington and Hunt, have staged a big rally of late: From Nov. 7 to Dec. 20, the yield fell about 50 basis points, representing a gain of 8.5 percent in just six weeks.

One of the main reasons for this late-year comeback, of course, is the dimming outlook for global growth and concerns that the Fed is tightening monetary policy too quickly, like the duo said. They didn’t get everything right — Hunt was off-base in predicting the Fed would pause its balance-sheet reduction earlier this year, for instance — but suddenly that worldview isn’t the tired bullish argument it seemed earlier in 2018.

Then there are the comments from Brian Edmonds, head of interest rates trading at Cantor Fitzgerald LP, three Fed rate hikes ago:

“There is a feeling at times, when the market really looks at what the Fed is doing, it looks like they want to raise rates when they can so they can lower rates if needed.”

Wouldn’t you know it? As of Dec. 28, bond traders were pricing in no additional rate increases in 2019 and a greater than 50 percent chance of a cut in 2020. Almost as if … Fed officials were resolute in boosting interest rates when the economy and financial markets were good so they could get close to a nebulous “neutral” level before it was too late? 

To be sure, a “bond” can mean different things to different investors, and not all fixed-income markets ended 2018 on a high note. U.S. corporate debt, for instance, has declined 2.76 percent and looks as if it will finish with its worst yearly loss since 2008. Globally, high-yield securities have tumbled 4.44 percent, also the worst performance in a decade. 

But that’s not what Gross and the others meant when they evoked a bear market in bonds. They were specifically calling into question the trend that pushed 10-year Treasury yields from as high as 15.8 percent in 1981 to 1.32 percent in 2016. It looked like they might be on to something when the rate reached 3.26 percent in October. Yet those emboldened bears couldn’t get their stories straight for why yields deserved to be so high, perhaps foreshadowing the rally to come.

Compared with 2018, the year ahead has yet to find a narrative among bond traders. Perhaps it’s watching for whether the yield spread between three-month Treasury bills and 10-year notes turns negative, which has anticipated recessions more accurately than the parts of the yield curve that inverted earlier this month. That gap is 33 basis points now, close to the lowest since September 2007. Or maybe advisers will recommend a larger allocation to cash, given the recent market volatility and the highest T-bill rates in years.

One thing’s for sure — not many strategists are prognosticating a doomsday for government debt in 2019. Even hedge funds and other large speculators have pared back their record wagers on higher yields. If 2018 is what a “bond bear market” looks like, then Treasury investors have less to fear than they thought.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

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

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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