This year has already delivered, according to bond market legend Bill Gross, the end of the great bull run in bonds.
n bond investors are taking a more nuanced view on the outlook for 2018, which they say could be remarkable not for the price action in bonds but the possible knock-on effect to bond proxy assets such as real estate investment trusts which are priced off the level of yields.
The US 10-year Treasury yield was just above 2.5 per cent heading into the US holiday on Monday, greeting the year higher.
But the market will not see 3 per cent for the US 10-year, not imminently anyway, says Angus Coote from Jamieson Coote Bonds.
“I think it’s unlikely,” he says, plainly because there would be significant consequences central banks would be unwilling to tolerate, and with ample ammunition speculative shorts are still at multi-year highs.
“Every year since 2011 we have had analysts forecasting far higher yields at the start of the year only for this to prove incorrect by year end. They are dusting out the same song sheet this year,” Mr Coote said.
“Is this the bear market in bonds? I think it’s certainly going to be a much tougher environment for investors and I would expect to see bond yields rise,” said Simon Doyle, from Schroders.
But he is reluctant to invoke any sensationalist predictions: “It doesn’t mean you’re going to get a bear market in bonds.”
As the market comes to grips with claims that 2018 could be the year that the script is rewritten for bonds, it is just as notable how bond proxies have performed.
Over the fourth quarter, n real estate investment trusts only slightly underperformed the broader equity market, rising by 6.28 per cent versus 6.75 per cent, including the benefit of the Westfield deal.
Into the third week of January, property stocks have fallen 3.05 per cent versus the 0.2 per cent gain for the broader equity market.
It is interest rate sensitive assets that Mr Doyle thinks will be most exposed to any meaningful turn in the bond market.
“I actually think the bigger risk is not about bonds per se, it’s the fact you have a lot of assets priced off bonds and risk has been mis-priced because of the view central banks will not change tack. It’s other assets that are more vulnerable to a back up in bond yields,” including infrastructure. “I probably worry more about how it flows through.”
The Schroders fixed income manager says that there is a stronger case for higher yields in 2018 because global growth is accelerating and excess capacity is working its way out of the system. “Our thinking this year is inflation in the US starts to rise,” he said.
In fact, for all the predictions of pain ahead, bond markets have been welcoming new money.
Mr Coote argues that with equities at all-time highs as they are in most advanced economies, the safety of the bond market will prevail.
“Prudent investors are going to, at some point, take money out of risk markets – equities and credit – and park it in safer havens,” he said. US 2-year Treasuries are yielding 2 per cent versus the S&P 500 dividend yield at 1.82 per cent.
“Investors will start to look at that and say, ‘would I rather buy the S&P at nosebleed levels, or do I want to buy risk-free US Treasuries at 2 per cent-plus?'”.
Inflows into US, global, and emerging markets bond funds hit 14, 16 and 76-week highs respectively for the week ending January 10, according to EPFR’s tracking.
“The trouble with bonds is investors have this view of stable, positive-returning asset classes. You’ve made money out of bonds. There’s a bit of a concern that that’s over and you could start to see some potentially negative returns from bond markets,” Mr Doyle said. Even Mr Gross, who has called time-of-death on the asset class, thinks bonds will deliver a positive return in 2018, according to his January investment outlook.
“We have begun a bear market although not a dangerous one for bond investors. Annual returns should still likely be positive, although marginally so,” Mr Gross wrote.