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Bad News for Bond Investors

A sharp falloff in bond prices would rattle equity markets that are now trading at record highs
Bond markets appeared to be further spooked by a report that China’s central bank, which owns $1.2 trillion in US Treasury bonds,  may be poised to slow or even halt its buying of US debt.
Bond markets appeared to be further spooked by a report that China’s central bank, which owns $1.2 trillion in US Treasury bonds,  may be poised to slow or even halt its buying of US debt.

Robust and synchronized global growth alongside central banks retreating from their easy money medication for markets has spurred plenty of conjecture that 2018 will wreak havoc for bond portfolios.

For nearly a decade, central banks around the world have been the biggest buyers of bonds, sending interest rates plummeting and stock markets soaring. Now, investors are starting to worry about what would happen if the richest nations start to scale back on a buying binge that most of them began to stimulate economies hurt by the global financial crisis, news outlets reported.

The most immediate fear: A sharp falloff in bond prices would rattle equity markets that are now trading at record highs. Beyond that, there is a looming concern that as the global economy heats up, inflation, a bond investor’s main worry, will start to inch up, fed by higher wage demands on the part of workers everywhere.

Central banks are still providing plenty of liquidity and investors have yet to see what kind of economic boost US tax reform delivers.

For all the worry of what higher yields entail for portfolios, bond investors notably stepped up last week and bought plenty of government debt, including a big chunk of long-term paper, including US Treasury 10-year notes and 30-year bonds. The need among many fixed income investors to reinvest income back into the bond market at higher current yields will help limit a sell-off in rates.

 "Your largest investor might be stepping back, that’s what spooked people,” said John Briggs, a bond strategist at NatWest Markets. “The market is very vulnerable to any change in supply and demand.”

That vulnerability has been on display in recent weeks, with many investors selling out of their bond positions, pushing the yield—which rises as bond prices fall—on the benchmark 10-year US Treasury bill up to a high of 2.59% on Wednesday from 2.3% late last year. It closed the week at 2.55%.

China Move Spooks Market

Bond markets appeared to be further spooked on Wednesday by a report that China’s central bank, which owns $1.2 trillion in US Treasury bonds, may be poised to slow or even halt its buying of US debt. China has total reserves of just over $3 trillion.

So far, China has made no official statement on its plans for its US Treasury. Analysts do not believe that the country, which under President Xi Jinping has taken pride in its standing as an elite member of the club of wealthy nations, would rashly unload the securities it has amassed over the years, SFGate reported.

To some experts, a move by China to pull back on its bond-buying could simply be seen as responsible-reserve management by one of the world’s richest central banks.

But there is another interpretation that gets at the simmering tensions between the United States and China over North Korea and trade. “It is possible too that China wants to signal to its people that it will not keep financing the US when the US is not treating China with respect,” said Brad Setser, an expert in global capital flows at the Council on Foreign Relations.

There is also a belief among many economists that the tax cuts recently signed into law by President Trump could worsen the United States’ financial position and make its debt less attractive as an investment.

The mere thought that China might choose to unload some of its treasury fed broader concerns about how the markets react as central banks in the United States, Japan and Europe normalize policies adopted to prop up faltering economies.

All told, the three central banks are sitting on $14 trillion in securities they have bought since 2009: a $4.4 trillion mix of treasury and mortgage securities held by the Federal Reserve; the European Central Bank’s $5 trillion in corporate and government bonds; and $4.5 trillion worth of bonds and exchange traded funds accumulated by the Bank of Japan.

Moreover, the view that the US government, in the wake of the tax cut package, will have to issue more securities to finance a larger budget deficit is giving bond investors pause.

And that is bad news for bond investors.

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