The Roarin’ 2020s And The Death Of The Bond Bull

In this century’s iteration of the “Roarin’ 20s,” the word “Roarin” has a decidedly negative connotation.

First, a deadly pathogen roared around the globe, leaving millions dead in its wake. Then, two years later, the Russian military machine roared into Ukraine, plunging Europe into the worst security crisis since World War II.

The implications for the global economy are profound. You could make a very long list, but if you wanted to encapsulate the macro and market impact of two crises in two years, you might simply point at the 40-year-old bond bull, which is currently bleeding out on the pavement.

The world’s pile of negative-yielding debt is now just a fraction of the mountain it once was, and US Treasurys are off to an egregious start in 2022. The inauguration of fiscal-monetary partnerships in response to the pandemic prompted even some long-time bond bulls to question their previously unshakable faith. And it wasn’t just policy. The vast demand destruction triggered by worldwide lockdowns turned out to be relatively short-lived, and it became clear fairly quickly that the inflationary side of the pandemic would be COVID’s legacy. On-shoring, disrupted supply chains and labor shortages became fixtures of the US economy, a conjuncture which persisted right up until the eve of the war.

The conflict in Ukraine “could prove the straw that broke the bond market’s back,” BofA’s Michael Hartnett suggested, in his latest. The QE students among you will doubtlessly recall that less QE can be accompanied by falling yields, a result that seems counterintuitive until you remember that the whole point of asset purchases is to inflate. But, when combined with a laundry list of other ostensibly bearish factors, the end of net asset purchases across developed market economies could be insult to injury for bonds, even if growth slows. Hartnett flagged the end of QE, before noting that with the ECB and the Fed “finally” turning hawkish and the EU “flipping quickly from austerity to fiscal excess in a belated attempt to develop military and energy independence,” the stage is set for higher yields.

But, perhaps more notably, he suggested the weaponization of the global financial system could imperil developed market bonds. The figure (below) just shows the AUM of the world’s largest SWFs.

The “era of sanctions and using financial instruments as weapons of geopolitical conflict creates uncertainty as to the safety and liquidity of government bonds,” Hartnett wrote.

Out of nearly $11 trillion in SWF AUM, almost $7 trillion is in the hands of oil producers and China. Their “willingness” to remain committed to US Treasurys and European government bonds is now in “doubt,” Hartnett remarked.

I’m skeptical. If liquidity is indeed an issue, it’s not clear where else SWFs are going to find it. There’s no deeper, more liquid market than the US government bond market. Obviously, that’s irrelevant if your central bank has its assets seized, but this is a case where the phrase “there is no alternative” can be taken quite literally. If you cross securities issued by all of the nations participating in sanctions on Russia off your list of investable assets, then you’re effectively saying you don’t want to hold reserves in dollars, euros, pounds, francs or yen. What else is there? As discussed here at some length on Saturday morning, CNY really isn’t a viable option outside of incremental, “around-the-edges” diversification.

In any case, it’s something worth pondering. In the same note, Hartnett wrote that the end of the Cold War brought about a “peace dividend,” a positive supply shock and deflation. The “new Cold War,” he said, will be accompanied by a tax, a negative supply shock and inflation.

For BofA, 2020 “marked the secular low in interest rates and inflation.” When we remember the 2020s, we’re likely to think “quick and volatile boom-bust economic and investment cycles,” Hartnett said.

“Roarin'” indeed.