It’s always darkest before the dawn, as the old saying goes, but I’ll becha you get every PM in town together and say “show your hands if you’re excited about cheap bonds,” you’ll get a crowd of full pockets, to paraphrase The Brain.
In fact, despite the highest yields on developed market govies in decades, some big investors are still inclined to trim their holdings over concerns that after a 40-year bull run, bonds have entered a secular bear market.
“Government debt should be cut to 50% of bond holdings from 70%,” Norway’s massive sovereign wealth fund said, in a letter to the country’s finance ministry this week. The behemoth, tasked with safeguarding Norway’s oil and gas riches for posterity, controls $2.3 trillion. The proposed shift would entail a $75 billion reduction in US Treasurys. The share allocated to JGBs would actually rise.
I should note that the fund’s recommendation isn’t a direct comment on America’s fiscal trajectory, let alone on US politics or foreign policy. If you read the letter, the fund’s just trying to work out the optimal strategy for maximizing fixed income returns across the entire spectrum of investable credit while retaining enough DM government bonds to cover liquidity needs “in periods of financial market turbulence. ”
Still, the letter includes multiple references to the pervasiveness of large debt overhangs across the developed world and gently notes that, “The degree to which bonds will contribute to dampening volatility in future crises will depend on the nature of the crisis.” In the event of a government debt crisis, for example, “one might expect government bonds to not have the same volatility-dampening effects,” the fund remarked.
That underscores a key (from an asset allocation perspective, it’s the key) concern in the post-pandemic world. The macroeconomic, sociopolitical and geostrategic dynamics behind the four-decade bond bull are reversing. As a consequence, the role of bonds, and particularly developed market sovereign debt, in portfolios needs to be reassessed. While they can still serve their traditional role as a volatility dampener, they can also be a source of volatility. As such, it’s no longer safe to assume a negative correlation with equity returns.
The figure below, from BofA’s Michael Hartnett, gives you a sense of just how much the world’s changed recently.
As you can see, we’re now witnessing the worst performance on record for 15-years and out US Treasurys measured on a 10-year rolling annualized basis.
The chart header hints at the ostensible opportunity. Similarly measured performance nadirs for stocks (1939, 1974, 2009) and raw materials (1933, 2018) were generational entry points.
Investors, though, worry that bonds’ problems are structural, or anyway not readily addressable. That doesn’t mean rallies aren’t possible. They obviously are, and indeed they’re inevitable. In the US context, for example, Scott Bessent could pull forward an announcement on cuts to coupon auction sizes to the November QRA. Assuming static demand, less supply means higher prices and lower yields.
But even those sorts of quasi-fundamental adjustments won’t do much to change the perception that DM government bonds are becoming — dare I say it — uninvestable above and beyond (admittedly huge) mandatory allocations.
Advanced economy sovereign duration is a “If it ain’t one thing, it’s another” / “Can’t win for losin'” sort of trade. It’s not just too much supply against a shifting buyer base. It’s also inflation, populism (on both the left and the right), deficits, protectionism, rearmament, redistribution, competition from AI-related debt sales by high-grade corporates and on and on.
It doesn’t help that Donald Trump’s hell-bent on subjugating the institution tasked with protecting the value of the world’s reserve currency. Trump’s late-week threat to cut off all trade with countries that run a surplus with America unless and until the Fed cuts rates, is almost surely a bluff. And Trump’s alluded to such an ultimatum for the FOMC on countless occasions previous, including in 2018.
But explicitly tying tariffs (already a sore spot for a lot of foreign holders of Treasurys) to demands on Kevin Warsh (who markets already worry will bow to political pressure) is a very bad look for securities backed by “the full faith and credit” of the US government.
If you’re wondering: I’d still buy the dip if US 10s trade with a five-handle. Not investment advice. Do your own research. Consult your local financial advisor who, like me, probably drives a regular 5 series, not an M5. (I bet he doesn’t own a Chanel beanie, though.)
