Carnage in bond markets as investors brace for new world order

According to strategists at Bank of America, the third great bond bear market is already underway, with government bond yields on track for their worst year since 1949. Previous bond bear markets stretched from 1899 to 1920 and from 1946 to 1981.

big picture

In a note to investors, Michael Hartnett, chief investment strategist at Bank of America, said the big picture is one of “deflation to inflation, globalization to isolationism, monetary to fiscal excess, capitalism to populism, inequality to inclusion, devaluation of the American dollar”.

Hartnett expects long-term US bond yields to exceed 4% by 2024,

This marks a sharp rise since August 2020, in the depths of the coronavirus pandemic, when the 10-year US bond yield fell as much as 0.5 percent.

But the bond sell-off has accelerated this month, amid rising inflation anxiety and as the US Federal Reserve has belatedly reversed its ultra-loose monetary policy.

The Bloomberg Aggregate Bond Index, the benchmark for the US investment-grade bond market, has fallen 6.2 percent this year, putting it on track for its worst quarterly performance yet. Since 1980.

Meanwhile, the Bloomberg Global Aggregate Bond Index, a comparable measure of global bonds, is down 6.6 percent so far this year.

The index has shown a total negative return of around 11 percent since its peak in January 2021, which equates to a drop in market value of around $2.6 trillion.

Bond sales also rebounded after the Russian invasion of Ukraine, which has increased inflationary pressures in pushing up food pricesenergy and other important raw materials increased considerably.

Even before the war, it was clear that the US economy was recovering strongly from the pandemic, with consumer prices rising to their highest level in four decades, while the country’s unemployment rate fell. at 3.8 percent.

Investors are increasingly convinced that the Russian invasion of Ukraine will accelerate the retreat from globalization, leading to a permanent rise in inflation and forcing central banks to tighten monetary policy more aggressively.

end of globalization

Larry Fink, director of BlackRock, the world’s largest asset manager, warned that “the magnitude of Russia’s actions will unfold in the coming decades and mark a turning point in the world order of geopolitics, macroeconomic trends and the capital markets”.

In its last letter to shareholdersFink warned that Russia’s aggression, and its subsequent disengagement from the global economy, “will prompt companies around the world to reassess their dependencies and re-analyze their manufacturing and assembly footprints, something that COVID had already prompted many to do.” start doing.” .

Fink argued that some companies could decide to move more of their operations inland or abroad, and that will likely increase costs and put pressure on profit margins.

“A large-scale reorientation of supply chains will be inherently inflationary,” he noted.

Howard Marks, Co-Head of Oaktree Capital Managementchose a similar theme in its latest investment memo.

Globalization, he argued, had allowed companies to cut costs by moving much of their production abroad to take advantage of cheap labor.

As Marks noted, “offshoring has undoubtedly contributed substantially to the low level of inflation experienced in the US over the past 40 years.”

But, he said, it wasn’t an outright bonanza.

maintain positive relationships

“Offshoring also led to the elimination of millions of jobs in the US, the hollowing out of manufacturing regions and the middle class of our country, and most likely the weakening of private sector unions.”

And it left countries and companies heavily dependent on maintaining positive relations with foreign nations and having an efficient transportation system.

“Recognition of these negative aspects of globalization has now swung the pendulum toward local sourcing,” Marks wrote. “Instead of the cheapest, easiest and most environmentally friendly sources, more importance will probably be given to the safest ones.”

Some analysts go further and argue that we are now witnessing a division of the world economy into two competing trading blocs, with the United States and Western nations in one camp, and Russia and China in the other.

They argue that friction between the two blocs has been evident since 2018, when the world’s two largest economies, the United States and China, were locked in a bitter trade war.

At the heart of the dispute was Beijing’s “Made in China 2025” program, which aimed to make China a world leader in strategically important emerging industries such as 5G, artificial intelligence and electric vehicles and biopharmaceuticals.

And they note that tensions were exacerbated by massive supply chain entanglements resulting from the pandemic.

Confronted with sky-high freight rates, lengthy port delays, and the difficulty of obtaining key components or finished goods in a timely manner, many US and European companies have decided to locate their factories closer to their consumers.

The war in Ukraine, which has highlighted Europe’s dangerous dependence on Russian energy, has accentuated the dividing lines between the two opposing camps.

Europe is trying to reduce its dependence on Russian gas, oil and coal as quickly as possible, to reduce Moscow’s leverage and cut off a key financial lifeline to its economy. The United States pledged last week to increase its shipments of liquefied natural gas to Europe.

However, moving away from globalization will come at a cost. Globalization stimulated world growth, while helping to mute inflationary pressures, allowing central banks to keep interest rates low.

Earlier this month, the US Federal Reserve raised interest rates for the first time since 2018, signaling that policy rates would likely rise to around 2.75 percent by the end of 2023, the highest level since 2008.

But many analysts believe the Fed will be forced to raise policy rates much higher to tame persistent inflationary pressures, which will only become more intractable as the era of globalization draws to a close.

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