Since the beginning of this decade, bond yields have been on the rise. This is not an isolated adjustment in a specific geography, but a transversal phenomenon observable in practically all benchmark markets. The US bond has surpassed the 5.0% barrier, the German one the 3.5%, -levels not seen sustainably since the beginning of the century-. But perhaps the most striking is the Japanese bond, which jumped above 3.0% after remaining at meager levels since the burst of the Japanese bubble in the early nineties.
One can refer to the spike in oil prices following the crisis in the Strait of Hormuz, the vigor of economic activity driven by the expansive cycle of artificial intelligence, or other cyclical factors to justify recent movements. However, we believe that behind this dynamic lies a clear long-term cycle change.
To assess it properly, it is advisable to compare the yield of sovereign debt against its evolution over time, taking as a reference the US bond, as it is the benchmark on which other markets apply their particularities. Since the peaks of the early eighties, when its yield exceeded 15.0%, the yields of this asset have experienced a systematic decline over four decades until reaching a historical low, slightly below 1.0%, following the outbreak of the pandemic. At that moment, it marked a floor, and since then it has traced a clear upward trend to the current levels.
Bonds have become bonds again
Are we facing a new paradigm? We think that more than a new paradigm, it is a return to normality, as can be deduced from a detailed analysis of the evolution of yields over the last sixty years. This movement seems to put an end to the exceptional situation in which this asset class has lived since the Great Financial Crisis, which financial analysts date to the summer of 2007, even though the general public identifies the beginning with the collapse of Lehman Brothers in September 2008.
Not surprisingly, many portfolio managers claim that the current situation is characterised by the fact that "bonds have become bonds again," in the sense that they offer an adequate yield, with their ability to generate capital gains from sharp movements in their yields taking a back seat.
It may be premature to state that the rise in yields, and the corresponding fall in bond prices, has ended. To analyse their expectations, it is advisable to divide their nominal yield into two parts: inflation and the residual that remains once this is eliminated, which we call real interest.
Inflation continues to be heavily influenced by oil prices and their expectations. The geopolitical environment, and more specifically the situation in the Strait of Hormuz, does not provide clarity on what will happen with it, but in a situation that approached normality, the price of oil should clearly be below $100, around $70. Unfortunately, the price of this commodity again depends heavily on what happens outside the United States, as the relaxation observed in the last decades due to the increase in production within its borders threatens to be coming to an end due to the signs of fatigue in the main shale oil fields.
High Demand for Loanable Funds
In addition to the above, there are two factors that are putting upward pressure on inflation. The first is economic activity, which is in a situation much more resilient than one might expect given recent events, with numerous armed conflicts that do not seem to have a quick or easy solution. The second is global trade, where the search is no longer for the most efficient supplier, but for the most reliable and safest (friend-shoring/ nearshoring). Rarely do the most reliable and the most economical options coincide; this means that supply chains are no longer a source of disinflation as they were in recent decades, but rather the opposite.
And regarding real interest rates, we are observing a high demand for loanable funds. Firstly, sovereign states are adding to their usual reasons for needing resources the increase in defence spending, given that the Earth has definitively left behind its dream of the "End of History" that Fukuyama erroneously predicted after the fall of the Berlin Wall. To this enormous need of states has been added the investment boom in artificial intelligence, whose figures are starting to be more than relevant even when compared to the macro magnitudes of the economy as a whole. And in economics, it is well known: with the same supply of available resources, the greater the demand for them, the higher the interest rate.
It is not easy to draw conclusions, but we could dare to say that we have returned to normality, leaving behind the phase of abnormally low yields. Bonds have become bonds again, so their appeal lies in their coupon rather than the potential for capital gains they may offer. And finally, the outlook does not suggest that there will be a decrease in their yields in the short term due to the resistance of inflation to decline or the high demand for loanable funds from both companies and states.
And a final opinion that is not sufficiently well-founded: we should not rule out that we are in a buying zone. This does not mean that it is free from shocks, but rather that it ensures yields that are likely to compare favourably with inflation in the coming years.