Is the bond bull market over?
With Donald Trump sworn in as the 45th president of the United States of America on 20 January could his inauguration mark the end of a 35-year bond bull run? We explore what Trump’s entry into the White House may mean for bond markets.
As soon as it was announced in November that Donald Trump had beaten Hillary Clinton in the race to the White House, benchmark 10-year US bond yields rose to their highest level since the start of the year.1
Bond yields also soared in the Eurozone following the election result, with German 10-year yields reaching their highest level since March 2016, while the 10-year British gilt yield reached its highest level since the end of May, prior to the UK’s vote to leave the European Union on 23 June.2
In order to understand what prompted bond yields to rise following Trump’s election, and why some commentators3 are suggesting that his presidency could mark the end of the bond bull market, it’s important to first understand how bonds work.
Bonds: The basics
Bonds, also referred to as fixed interest securities, are fixed-term IOUs issued either by governments or companies looking to raise money. In exchange for you lending your cash, the bond issuer will pay you interest for a fixed term. If you buy a bond when it is first issued, when it matures you should get your money back in full.
Bonds are also traded on the open market, so you can buy them at any stage of their life and not just at the time they are issued. However, if you buy them after the initial issue date, you’ll pay the market price for them at that time, which could be more or less than the price when they were first issued, and therefore more or less than you would get back when the bond matures. You may also get a lower or higher percentage return, or yield.
Bonds issued by governments, which are known as gilts when issued by the UK government, are often perceived as safe haven investments because countries are generally considered to be more financially secure than companies, as they are less likely to fail to repay the sum borrowed or keep up with payments of interest. However, while corporate bonds are viewed as riskier than government bonds, there have been occasions when some countries have been unable to meet repayments. You could lose some or all of your investment if the bond issuer can’t repay the capital when it’s due, or meet interest payments.
Why are bond yields rising?
The two main factors which affect a bond’s price are interest rates and inflation.
When there are concerns that higher inflation is on the horizon, the price of bonds tends to fall, while interest rates and bond yields rise. This is due to the fact rising inflation makes it less attractive to hold government bonds, because you are locked in at interest rates which may not keep up with the cost of living in years to come. Rising interest rates reduce the value of existing bonds which carry lower rates.
Conversely, when interest rates fall, the price of bonds, including gilts, rises, because returns from them can be more attractive than those offered by cash accounts.
President Trump’s policies are expected to produce strong growth, with his focus on infrastructure spending providing a boost to the US economy. The Federal Reserve has already pushed up rates in December by 25 basis points to 0.5%-0.75%, and predicts three further interest rate rises in 2017.4
Following December’s rate increase, U.S. bond yields rose as high as 2.63%, having already increased more than 0.8 of a percentage point since Trump’s election in November.5 Yields on 10, 20 and 30-year gilts rose as high as 1.515%, 2.059% and 2.171% respectively on the day of the US rate rise, the highest levels for 20 and 30-year gilts since the EU referendum vote.6
Where next for bonds?
It’s impossible to say what will happen to bonds as Trump’s presidency progresses, as it is far from clear yet which of his plans definitely will be implemented during his tenure.
If President Trump does have a positive impact on US economic growth, while the UK's economy deteriorates as our exit from the EU is negotiated, that could lead to further sterling weakness spooking foreign investors in gilts and driving yields higher still.
If, however, Trump decides to pursue some of his more protectionist policies, this could prompt bond yields to fall, as a tariff war would damage economic growth.
It’s important to remember that even if we have reached the end of the current bull run, gilts and bonds remain a good diversifier in a balanced investment portfolio, as their prices tend to be affected by different market conditions than share prices.
To get an idea of how risky a particular bond is you should look at its credit rating, which is an assessment of the risk of a company or government not paying back its debt, carried out by a specialist agency. Ratings usually range from AAA, which is the highest rating, to C or D, which are the lowest.
Bonds with higher credit ratings are adjudged by the agency to carry less risk, but offer lower rates of interest. Like all investments, bonds come with risk and you could lose money. If you’re unsure, seek professional financial advice.
Past performance of investments is not a reliable indicator of their future performance.
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