How quickly they forget. For 30 years, mainstream analysts have been declaring the end of the secular bull market in bonds. And for 30 years, they’ve been dead wrong.
Consider the recent history of the economic recovery since the Great Recession. Specifically, bond yields spiked after the Federal Reserve wrapped up quantitative easing (QE) in the spring of 2010. Scores of analysts declared the end of the bond bull. Were they right? Hardly. Rates cratered alongside the Fed’s about-face on monetary policy, as the central bank double-downed on electronic dollar creation with the announcement of QE2.
More notably, the 10-year yield doubled from approximately 1.5% to 3.0% in the 2nd half 2013. Bloomberg News surveyed banks and securities companies on where the 10-year Treasury yield would finish 2014. Economist forecasts averaged 3.41%. Not a single individual of the 60-some-odd professionals anticipated lower rates. Where did the 10-year finish? Near 1.9%.
So here we go again. Presumably, a pro-growth Trump agenda coupled with a rate-hiking Federal Reserve means higher rates will break the back of the three-decade bond bull. Color me skeptical.
1. Unified ‘Shmoonified.’ Congressional Republicans Will Not Agree Across The Board. There’s a notion that the controlling party in both the House and the Senate will pass every Trump-inspired proposition, from infrastructure spending to trade agreement restructuring to immigration reform to Obamacare replacement. Granted, there is widespread support for a massive modification of the increasingly uneconomical Affordable Care Act (ACA). On the flip side, why would fiscally conservative folks rubber stamp an agenda that increases the national debt? Why would they approve borrow-n-spend annual deficits that constrain future economic growth?
Conservative factions of the Republican party hold certain non-negotiable edicts. For example, a cursory glance at Tea Party mandates include an end to deficit spending as well as a balancing of the national budget. Should the President-elect insist on borrowing to rebuild the infrastructure as well as the nation’s military – should he advocate fiscal spending without cutting back elsewhere – one should expect strong resistance.
2. The Global Economic Landscape Remains Shaky. The U.S. may be backing away from quantitative easing (QE) and zero percent rate policy (ZIRP), albeit at a snail’s pace, but the rest of the world is still committed to pushing rates as low as possible. Indeed, the rest of the world’s central banks are purchasing assets (e.g., government debt, investment grade corporate bonds, higher-yielding junk corporates, stocks, etc.) with QE “funny money” in the hopes that it will boost economic growth. The results have been mixed at best.
The bounce higher in world interest rates off of all-time summer lows may have been concerning to monetary policy leaders outside of the United States. The 50 basis point jump in global yields after Trump’s election had to be downright alarming. In fact, while the Dow has been able to notch record highs and the S&P 500 has been able to approach its peak, foreign stocks have been much less fortunate. The iShares All-World ACWI ex U.S. Stock ETF (ACWI) is back to where it began the year; it is down 6% since mid-September.
It is safe to say that entities like the European Central Bank (ECB) and the Bank of Japan (BOJ) are not going to throw in the towel. They want to lower borrowing costs; they believe they need lower borrowing costs. With no end date in sight for the ultra-accommodating measures, falling yields overseas will keep Treasuries and U.S. corporates from straying too far from a historical spread. The 10-year Treasury’s spread with that of the German bund is already peaking.
3. A Less-Than Virtuous Circling Back To Risk-Off Treasuries. How much of a rise in the U.S. dollar due to bond yield tightening can riskier assets tolerate? Not much more. The greenback has already made it back to levels last seen in early 2003, when the Fed’s relentless campaign to lower interest rates finally sent the U.S. dollar downward for the better part of the next decade. Meanwhile, the dollar’s elevated status of the last two years has been a significant headwind for the earnings of S&P 500 corporations.
So far, U.S. stocks have bene in a celebratory mood. In spite of the U.S. dollar’s surge. In spite of the yield spike. On the other hand, emerging market stocks have seen massive outflows on the rising dollar, rising bond yields and the possibility of a trade war. Vanguard Emerging Markets (VWO) has fallen 7% since the U.S. election.
In truth, manufacturing may not get a much-needed lift if borrowing costs for corporations are higher and if the stronger dollar hits U.S. exports even harder. President-elect Trump has to be aware of this reality. It follows that as much as candidate Trump chastised the Yellen Fed for not raising interest rates, he is going to need them to be every bit as dovish (if not more so) in the year ahead. Otherwise, much like the way that the U.S. debt downgrade from AAA to AA actually sent investors back into bonds for safety, investor demand could circle back to bonds should higher borrowing costs alongside a rising dollar damage worldwide business prospects.
You can listen to the ETF Expert Radio Show “LIVE”, via podcast or on your iPod. You can follow me on Twitter @ETFexpert. Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.