Regime Change in Bond Markets?

Four factors argue against an imminent regime change in major global bond markets.

With a steady repricing of global bond markets having contributed to a sharp plunge in global stock markets, there could be a whiff of a new era in the air. Given the failure of both markets and central banks to forecast inflation accurately, we should all be humble about the level of precision attached to the timing or nature of the bond market’s next chapter. What we can say is that any such shift will likely be cyclical rather than secular.

After a material repricing of 10-year U.S. Treasuries since September 2017, four factors argue against an imminent regime change in major global bond markets.

First, market pricing of policy rate expectations appears reasonable in the context of a mature U.S. growth cycle and a gradually normalizing inflation environment. The U.S. futures market is now pricing roughly four additional rate hikes through January 2020. This is the first time since the Federal Reserve began publishing its “dot plot” (a projection of where it expects the policy rate will be in the long run) that market pricing has caught up with the Fed.

Second, global bond markets have become increasingly integrated – a spillover effect from post-crisis unconventional monetary policy across major central banks. The Bank of Japan (BOJ) and the European Central Bank (ECB), for example, have reiterated their commitment to loose monetary policies for the time being. Japanese and European overseas bond purchases could well constrain the cyclical repricing of other advanced economy bond yields.

Third, the effects of past quantitative easing matter. Central banks have removed large amounts of duration and convexity from the hands of private market participants. The stockpile of bonds held by these central banks is like a wet blanket thrown over past and potential sources of volatility.

Finally, the equity market correction seems to be a reaction to the lofty exuberance that followed U.S. tax reform and the remarkable strength of global growth. The reining in of extreme equity valuations likely will not stop bond yields from repricing gradually higher in line with the cyclical recovery, and in fact reduces the likelihood that the repricing becomes disorderly (thereby undermining an already mature recovery).

Risks that could usher in a new era for bonds

At the same time, there are three main sources of uncertainty around how, or indeed if, regime change occurs in bond markets.

Most modern U.S. business cycles have been killed by some form of monetary policy shock, or so the saying goes. In the present cycle, the intersection of monetary policy shocks and inflation risk is, atypically, fiscal policy. It is arguable that the substantial uncertainty around the U.S. tax package’s impact on the fiscal deficit, growth and inflation is so high that there should be more risk premium in long-term bond yields than is presently the case.

Further, the integration of major bond markets may eventually become a problem as the ECB and the BOJ attempt to normalize policy. Japan’s exit from yield curve control could be particularly challenging, if Switzerland’s messy exit from price targeting is any indication.

Last but not least is the U.S. dollar, which has depreciated by 10% over the past year versus a basket of global currencies. Dollar weakness has served to export loose U.S. financial conditions to the rest of the world. Interest rate differentials have been persistently in favor of the dollar, reflecting the U.S. economy’s earlier recovery. Instead, markets have repriced the dollar progressively weaker as the rest of the world has begun to close the growth gap with the U.S.

If America’s late cycle fiscal stimulus were to reestablish U.S. growth leadership, the dollar could yet recover. All else equal, dollar appreciation would export tighter financial conditions to the rest of the world. Given strong cyclical recoveries, depreciating currencies against the dollar could hasten Europe’s and Japan’s exits from quantitative easing, reignite capital outflows from China (thus forcing China’s central bank to tighten policy further) and weigh on commodity prices (a negative terms of trade shock for many emerging markets).

The common thread running through these three risks is that higher bond yields in the short run reinforce the secular case for low bond yields over time. Because of ageing populations and persistently high debt levels across most of the developed world, the sensitivity of global GDP growth to interest rates remains high, even after the healing of the past decade.

Cyclical repricing is not a page-turner

None of the above aims to suggest that bond yields won’t continue to rise as the global cyclical recovery matures. Cyclical repricing is not a new chapter for bond markets. The central question is around the persistence of a low-volatility interest rate environment, which worsens the trade-off between higher yields cyclically and lower yields on the secular horizon.

The lesson of the equity correction for the bond market relates to the dangers of an extended period of artificially suppressed volatility. The internal contradiction between central bank efforts to unwind excessive stimulus without generating volatility is prone to be tested as the synchronized global recovery extends.

Enjoyed this article? Subscribe to receive updates to the PIMCO Blog.

The Author

Gene Frieda

Global Strategist

View Profile

Latest Insights


Emerging Market Investing: A Multi-Asset, Granular and Dynamic Portfolio Approach

This Research paper is a joint effort between PIMCO and GIC, Singapore’s sovereign wealth fund. GIC authors Grace Qiu Tiantian Ph.D., Ding Li, and Zhihui Yap collaborated with PIMCO’s Josh Davis, German Ramirez, and Helen Guo to produce this report.


PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH- . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

XDismiss Next Article