Global Bond Rout Sounds Warning for Equities

The global equity rally that’s repeatedly shrugged off rising geopolitical uncertainty now faces a new test: the apparent certainty of higher borrowing costs. The spike in bond yields is just getting started, according to legendary fixed-income investor Jeffrey Gundlach. For Ray Dalio at the world’s largest hedge fund, the era of central-bank stimulus is now over.

Bond market stress showed signs this week of spilling over into stocks as well as other assets from gold to silver. Equities have reached all-time highs even in the face of North Korean missile tests, Persian Gulf confrontations and Washington turmoil this year, as investors bet the global economy can withstand higher interest rates. That hurdle is getting closer, Bloomberg reported.

Sure, there have been calls before that the three-decade bond bull-market is finished, only for fixed-income returns to rally back. The Federal Reserve may well be close to cutting the size of its balance sheet and European policy makers are inching toward tighter policy, but cash is still sloshing around at the Bank of Japan ready to buy bonds.

The last time simultaneous declines occurred between bonds and stocks was during the taper tantrum in 2013 when the Fed hinted at reduced stimulus. Of course, the S&P 500 Index has returned above 10% a year since then.

The Wall Street consensus for higher bond yields this year had been tested from the highs reached in March for 10-year treasuries as investors doused expectations for a growth boost spurred by Donald Trump’s administration. A slide to 2% then looked far more likely than a rally to 3% until central banks in Europe, the UK and Canada last month all delivered more hawkish commentary.

A Long-Standing Pledge

A rout in treasuries and bunds intensified this week as the European Central Bank said it’s contemplating removing from its message a long-standing pledge to expand or extend the bank’s bond-purchase program if necessary. Global equities are on course for a second weekly loss, while gold and silver are declining as higher bond yield pressure non-interest bearing assets.

The recent selloff is a sign of more pain to come for US bond bulls, according to Gundlach, DoubleLine Capital’s chief executive officer, which oversees $109 billion.

The last time the yield on 10-year treasuries reached 3% was more than three years ago, when the Fed was still in full loosening mode and the Bank of Japan’s easing policy was expanding. Gundlach expects that to happen again, without specifying the time frame. The yield closed above 3% on just two days in December 2013.

Still, Australian government debt auctions this week showed demand remains strong from yield-hungry investors, aided by the local central bank’s refusal to follow peers in taking a hawkish tilt. And the Bank of Japan on Friday announced its first unlimited fixed-rate bond-purchase operation since February, driving 10-year yields back down from the highest since February.

Yields Higher, Stocks Drop

Bond yields stayed elevated after a sell-off in debt this week stoked by a number of central banks stepping up talk of tighter policy conditions. The yen slumped to an eight-week low after the Bank of Japan reinforced its cap on the nation’s 10-year rates.

European stocks fell as traders awaited US jobs data for clues on the health of the world’s biggest economy that may give fresh impetus to bets on the Federal Reserve’s policy outlook. Bearish comments from investors Gundlach and Dalio added to the impression of a sea change for bonds, with German 10-year yields climbing to an 18-month high as treasuries also slipped. Emerging-market sovereign dollar bonds posted their worst week since November, while oil dipped below $45 a barrel.

Comments from central bankers “clearly and understandably” signaled that stimulus will be tapered, according to hedge-fund investor Dalio. European Central Bank policy makers considered removing a pledge to increase their bond-buying program if needed when they met last month, according to accounts of the central bank’s June 7-8 meeting that were published Thursday. The bond rout risks spilling over to stock markets as higher borrowing costs hurt company profits.