The End Of The 40-Year Bull Market In Bonds. What Next?
The Importance Of Inflation And Interest Rates
The sharp drop in Treasury prices thus far in 2022, the greatest since the days of Paul Volcker’s historic rate increases of the early 1980s, marked the end of a four-decade bull market. The magnitude and length of this historic bull market since the peak of interest rates at circa 20% has had an enormous impact on capital markets in the intervening years.
The steady decline in interest rates lowered borrowing costs which produced significant economic expansion and stock market increases (albeit with notable setbacks along the way), encouraged the assumption of enormous levels of debt through all levels of the economy, and attracted an enormous amount of investment capital into yield-bearing securities of varying levels of creditworthiness.
The global economy finds itself at an important inflexion point in early 2022 as central banks signal their intention to aggressively pursue policies of interest rate increases designed to combat the inflationary effects of the COVID-induced supply disruptions. The effect of interest rate increases on the highly levered global economy, and financial markets, is sure to be ultimately negative.
It remains to be seen how many rate increases will be implemented before the ensuing economic pain forces central banks to halt and reverse the process.
The ultimate scope and duration of the coming round of rate increases will be a function of the nature of the current inflationary pressures and the negative leverage embedded in the global economy to rising interest rates. Properly gauging these two variables will provide valuable insight in assessing the character of the next bear market in stocks as well as the subsequent bull markets in bonds and equities.
We discussed the prospects of both inflation, and the extent of the coming rate increases in the recently published February issue of the Global Investment Letter. Not surprisingly, our views are at odds with current consensus thought.
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