Global Bonds Swoon as Investors Bet on Inflation, Growth

By Daniel Kruger and Mike Bird Features Dow Jones Newswires

Selling in government bonds intensified around the world Monday, as a pick up in global growth is leading investors to embrace stocks and other risky investments while dumping more staid holdings like bonds.

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The yield on the benchmark 10-year U.S. Treasury note settled Monday at 2.695%, its highest closing level since April 22, 2014. Germany's five-year bond yield touched positive territory for the first time since late 2015. Yields also rose for the government bonds of France, Italy, the U.K. and Japan.

Bond yields have climbed since the start of the year, spurred by signs of growth and increasing expectations for a pickup in inflation. Economic expansion can push investors into riskier assets while inflation poses a threat to the value of government bonds because it erodes the purchasing power of their fixed payments.

Some investors said those expectations, combined with growth in the supply of Treasury debt and a pullback in stimulus from central banks that had been supportive so far, has helped drive the selling.

Investors are closely watching the declines in government bonds because the 10-year Treasury is a key foundation of global finance, influencing borrowing costs for consumers, businesses and state and local governments. Ultralow yields in recent years have also helped boost stocks, by making them look more attractive to yield-seeking investors, while driving record debt issuance by U.S. companies.

"The Treasury market's going to be taking it on the chin," said Andrew Brenner, head of global fixed income at NatAlliance Securities. "You've set yourself into a bear market."

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The endurance of persistently low bond yields, even while major stock indexes around the world have soared to new heights, has long confounded analysts and investors. Many had expected yields to rise in 2017, lifted by a surge of growth and inflation. Instead the 10-year Treasury yield finished the year lower than where it began.

Now, some are betting the selling will continue, in part because bond yields are rising as central banks around the world are sending signals that they are reconsidering postcrisis stimulus programs. The European Central Bank has scaled back its monthly bond purchase program to EUR30 billion ($37.1 billion) in January from EUR60 billion ($74.2 billion), while the Federal Reserve is reducing its reinvestment in maturing bond proceeds. The Fed is also expected to continue raising interest rates, signaling three rate rises this year and two more in 2019.

European bond yields ticked up almost across the board on Monday. The rise of five-year German government bond yield as high as 0.016% on Monday was accompanied by Italian 10-year yields climbing above 2%, Spanish yields reaching as high as 1.44% and French yields hitting 0.982%.

Deutsche Bank analysts believe the selloff is still in progress, and expect a 1% yield on the 10-year German bund, which closed at 0.634%, and a 3% yield on the 10-year U.S. Treasury by the end of 2018.

"They're finally normalizing," said Jack McIntyre, who manages global bond portfolios at Brandywine Global Investment Management. "The way we're positioned is for European rates to better reflect European fundamentals. That process has started."

The Bank of Japan has an official target of a 0% yield on 10-year government bonds and has stepped in to buy debt when yields reach around 0.1%, signaling its commitment to keep borrowing costs low. At 0.085%, 10-year yields have crept closer to that trigger point through January, rising further Monday.

Fiscal stimulus in the U.S. is also expected to push the budget deficit sharply higher, which has some investors and analysts concerned that a wave of new bonds will overwhelm investors' demand for the debt. Some analysts said the U.S. tax cut and plans to boost in spending on public works projects could push up wages, feeding into higher inflation readings.

"There are a number of factors seemingly converging to challenge to long-run bull market that's been going on for most, if not all market participants' lifetimes," said Richard McGuire, head of rates strategy at Rabobank.

Despite stronger global growth, bond yields are still low by historical standards and inflationary pressures remain tepid across much of the world. That leaves some analysts skeptical about whether the current move higher in bond yields will continue to accelerate.

At its meeting last week, the ECB's Mario Draghi said he saw "very few chances at all that interest rates could be raised this year."

"The way that we're seeing it is I think it's going to take more of an upside surprise on inflation to give this move continued momentum," said Fraser Lundie, co-head of credit at Hermes Investment Management.

Rabobank is still generally positive on U.S. Treasurys and believes recent moves are more likely to be reversed than continued over the course of the year.

"I think it is a very bold claim to suggest that a trend that is far more than 40 years in the making is now behind us, and that we're about to enter a new era for bonds," Mr. McGuire said.

Write to Daniel Kruger at Daniel.Kruger@wsj.com and Mike Bird at Mike.Bird@wsj.com

(END) Dow Jones Newswires

January 29, 2018 16:18 ET (21:18 GMT)