For the vast majority of the current crop of Wall Street traders, a bull market in bonds is really all there’s ever been. One has to go back more than 30 years — to the late 1970s and early 1980s — to find the last bear market in bonds.
Yet things have changed in 2013.
The consensus on Wall Street now expects the Federal Reserve to announce a tapering of the pace of monthly bond purchases it makes under its quantitative easing program at the September FOMC meeting. The mere thought of such a decision in the minds of traders and investors was enough to spark a violent sell-off in the Treasury market this summer — the yield on the 10-year note is up 118 basis points since May 2 alone at current levels near 2.8%.
Now, the long bull market in bonds is widely perceived to have come to an end.
“A remarkably low 3% of investors expect long-term bond yields to be lower in 12 months,” said BofA Merrill Lynch chief investment strategist Michael Hartnett of the bank’s August Global Fund Manager Survey.
As Treasuries have declined in value this year, many bond investors have seen something they aren’t used to seeing: negative returns in their monthly statements.
In fact, according to ConvergEx Group chief market strategist Nick Colas, there may be a lot of people out there who didn’t even know that was possible.
“I have had more than one high-net-worth broker tell me that his clients think the ‘Risk Free Rate’ means that you never see a mark down in the value of your Treasury portfolio,” says Colas. “They are only now discovering their error, and the realisation is unwelcome.”
The “risk-free rate” is a theoretical concept used in ubiquitous financial calculations like the capital asset pricing model to value securities. The “risk-free rate” in these models usually refers to the yield on U.S. Treasuries, where the rate of return (yield) is viewed as “riskless” because Treasuries don’t contain default risk.
So, apparently there are investors out there who heard the term “risk-free rate” and assumed that an investment in Treasuries would never lose money.
“Fixed income isn’t a one-way bet,” says Colas. “That fact spills over into everything from corporate capital allocation to equity market valuations. And it will take longer than to Labour Day to accommodate this new fact.”