6 Min Read
* Thirty-five years of bond market gains may be over
* Central bank policy turn could be watershed moment
* Shifts in demographics, globalisation changing tide
* But disinflationary forces should keep yields low
By John Geddie
LONDON, Sept 30 (Reuters) - No one yet has made money from calling an end to 35 years of gains in world bonds, but that has not stopped investors fretting that an era of central bank largesse is drawing to a close and a seismic shift in global markets is under way.
When the biggest debt funds say prices will fall and newspaper columns warn of a bubble set to burst and wreck people's savings, even sceptics find it hard to dismiss the latest episode of jitters as just another ill-advised attempt to call the bottom of the longest bull market in history.
Economists argue shifts in demographics and globalisation are finally turning the tide, while policy-watchers say the Bank of Japan's commitment last week to draw a line under further yield falls is the watershed moment they have been waiting for.
But even for those bold enough to call the turn, the pace of the change in a world devoid of growth and inflation could mean years of waiting to find out if they were right.
"You can easily imagine looking back on last week in two or three years time and saying the BOJ was the start of this," said Michael Metcalfe, head of global macro strategy at State Street.
In the world's largest economy, the United States, yields on 10-year government bonds have steadily fallen from around 15 percent in the early 1980s to record lows earlier this year of 1.37 percent.
In Japan and Germany, yields of around 8 percent a couple of decades ago are now below zero -- meaning demand for their debt is so high that investors are paying for the privilege of lending to these governments.
Economists at M&G say these broad trends can be explained by a population boom after the World War Two which boosted the workforce at the end of the 20th century, keeping wage inflation low and the need for savings assets like bonds high.
Since the 2008 global financial crisis, central banks have played a much more direct role in keeping yields low -- slashing interest rates and spending trillions of dollars on bond-buying splurges to try and bolster a fragile economic recovery.
And over the last decade, Reuters polls show that economists have consistently overcooked their expectations for bond yields, expecting central bank efforts to nurture growth and inflation to finally pay off. Graphic: tmsnrt.rs/2d9UNq8
So why should Deutsche Bank's claim that the demographic trends that have driven markets are reaching 'inflection point', or bond giant PIMCO's expectation that yields will rise as central banks run out of rope, carry more currency now?
Partly, it seems, these warnings come as investors are losing faith in the ability of financial assets to appreciate any more.
The latest monthly survey by Bank of America Merrill Lynch showed fund managers reckon equities and bonds combined are near their most overvalued and have ramped up their holdings of cash as a result.
Investors also get wary when terms like 'bond bubble' start to enter public discourse. Google searches for the term have hit their highest in over a year in recent weeks and cropped up in stories from the Sydney Morning Herald to Germany's Die Welt and Britain's The Times.
"The more people talk about it, the more likely it becomes. Investment decisions are made on a mixture of emotion and analysis, so it can prove self-fulfilling," Louis Gargour, chief investment officer at LNG Capital, said.
But while some bond market veterans agree a three-decade rally may have run its course, they are not expecting a sharp turnaround.
They argue that even if the BOJ's shift last week is a tacit acknowledgment that monetary policy is reaching limits, heavily-indebted governments have little room to take up the slack with fiscal stimulus.
And with their banks stuffed full of bonds that would be battered by a sharp rise in yields, authorities will be eager to keep inflation under control.
"When people think things are completely mispriced and there is going to be blood on the streets, their model is often that they expect rates to return to the post-war average," said Andrew Balls, PIMCO's bonds CIO.
"The argument between 1.5 and 2.5 percent is much more modest than the argument between 5 and 6 percent."
There are, of course, more alarming scenarios out there.
Jim Leavis, head of retail fixed interest at M&G, said signs of a turn towards protectionist trade and labour policies -- as seen through Britain's vote to leave the EU in June and the rhetoric of U.S. presidential hopeful Donald Trump -- could stoke inflationary pressures through wages in certain countries.
"If globalisation went into reverse, I think you would end up with higher inflation and bond markets would have a rough time," said Leavis.
"Our view is that yields are too low here, but they probably stay lower than people expect for a long time."
On the other side though, said Leavis, developments in technology could see many jobs automated, keeping downward pressure on wages.
The consensus appears to be -- not least because of a slowdown in the world's second biggest economy China -- that disinflationary forces have the upper hand.
For Standard Life's Andrew Milligan, an investment veteran of 30 years, this has created an expectation that while the bond rally may be over, any reversal may be a long time coming.
"Although the bull market in bonds may be over, that doesn't mean a bear market is beginning." (Reporting by John Geddie, Dhara Ranasinghe, Abhinav Ramnarayan; Writing by John Geddie; Editing by Toby Chopra)