Bonds are not a safe haven

1st July 1940: British recruits grenade training at an Eastern Command Depot. (Photo by Fox Photos/Getty Images)

After the Bank of Japan said it would target the 10-year JGB around zero per cent last week, and the Federal Reserve left rates on hold, bond rates across the globe rallied into the weekend.

US 10s closed at 1.6150% on Friday, well down from the previous week’s high of 1.75%. German 10s were back below zero with a yield of -0.08%, Japanese 10s are at -0.05%, and 10-year gilts in the UK ended at +0.72%. That’s well down from the 0.95% peak the week before.

It all means the quiet riot that was happening in Japanese and global long bond rates since July is in hiatus, and has perhaps ended. At least that is what traders are betting right now.

But with their eyes on the investment horizon ahead, Nikko Asset Management’s global multi-asset team say bond yields “are at such low levels that the risk-return profile is asymmetric” and therefore “bonds are not a safe haven” any more.

Nikko highlights that the correlations and relative volatility between bonds and stocks are at levels that means they are both similarly risky and more likely to move in the same, not opposite directions, in the period ahead.

That questions conventional wisdom that bonds are a buffer to stock market volatility. But Nikko say that while bonds and stocks have had a negative correlation for the past 15 years (that is, they move in opposite directions) a longer term look over the past 40 years shows there was a long period where bonds and stocks moved up and down together.

They say markets “may just be about to enter another period where bonds and equities are highly correlated”. That’s because of the asymmetric risk, Nikko highlights.

“Continuation of ultra-accommodative unorthodox monetary policies can keep yields anchored at very low levels for a very long period of time. But they cannot push them much lower across most developed markets.”

They also say that the move in central banking circles, where bank of England governor Mark Carney has ruled out negative rates, where Fed chair Yellen appears to have done likewise, and the recent moves by the Bank of Japan means “the hurdle is high for it to drop rates any further into negative territory”.

Inflationary risks around the globe, not just the United States, are also rising Nikko says, which further complicates the outlook for bond rates. An inflation shock would be the death knell to the bond rally and “any change in investor attitudes or an unexpected inflation shock could lead to a sharp and disorderly sell-off in bonds at the very same time that equities are selling off”.

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