Let’s put the drop in global bond prices and the rise in bond yields (which move inversely to the price) into context.
Yes, bond yields have surged dramatically over a short period of time as bond investors (vigilantes?) demand a higher return on their investments.
This as central banks and governments continue to flood the economic system with liquidity to fight the effects of the pandemic leading to concerns inflation will not only increase but get out of hand.
Here are some instructive charts assembled by J.J. Johnston, EVP & Chief Strategist at Davis Rea Investment Counsel, who brings a global perspective, years of experience, and a sober eye to the recent developments.
First off, the chart below shows the rate of change in U.S. 10-year and 30-year Treasury yields, which indeed indicate a rapid jump over the last six months from depressed levels, compared to previous moves going back to 2007
Now, let’s look at data spanning nearly 25 years comparing the spreads between the U.S. 10-year yield minus the 2-year yield, and those of the U.S. 30-year yield minus the 5-year yield.
That’s followed by the spreads between U.S. 10s and 2s and 30s and 10s.
A steepening yield curve usually indicates an improving economy and the expectation of some inflation, so longer-dated bond yields rise to compensate investors for the risk they’re taking.
Conversely, a flattening or inverted yield curve often signals a weakening economy, which sees short-term bonds sold off and rising yields, while longer-dated bond prices move higher and yields fall as investors look for protection in the future.
(And, we say all of this while acknowledging that the bond market is currently distorted as central banks buy shorter duration bonds to keep interest rates low.)
What are the charts above telling us?
That the difference between these various Treasury yields is only slightly above the average going back to 1997.
Johnston calls the move in yields a “near-term scare”, and that they don’t necessarily mean interest rates are going to keep marching higher.
In fact, a quick move upward in interest rates can cool off and mitigate inflation by making the cost of lumber and housing, for example, more expensive.
Lastly, we look at Government of Canada bond yield spreads, which sit right around the average of the last 25 years.
They also show Canada is further ahead of the U.S. in normalizing interest rates from historically ultra-low levels.
That’s according to comments from John O’Connell, Chairman and CEO of Davis Rea Investment Counsel.
In addition, while new orders for manufactured goods in the Canada and the U.S. are solid, according to Johnston, the ability to fulfill those orders is constrained because of pandemic-induced supply chain constraints.
That will likely put a lid on the price of goods and prevent economies from running at full tilt during what’s expected to be very strong economic growth in the second half of this year.
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