Break with the past:Bonds,The king is dead;long live the king

It must be that time of the year. Over the last 24 hours, a number of BondGurus have declared the three-decade-old bond market rally over (yet again).

One feels for high volume and extreme price sensitivity global markets (FI andFX), and hence their preoccupation with panic headlines. To put that inperspective, at 2.5%, 10Y bond yields are only back to Mar ’17 level, while the10/2 yield curve is merely back to Christmas. Both remain in a long-termdeclining pattern. The same applies to 30Y and the 30/2 yield curve, whileneither 5, 10 nor 5/5 breakeven rates have changed much over the past year.

Nevertheless, a changing economic backdrop and CBs’ rethink of their policytools could (this time) create much higher asset price volatilities. As discussedin our ’18 preview, we view the recent coordinated global recovery as a giftfrom equally coordinated monetary policies (since the Feb ’16 ‘Plaza Accord’),massive infusion of CB liquidity (~US$3.5 trillion for G4+Swiss since Feb’16and US$2.2 trillion in ’17 or growth rate of ~15% vs global GDP nominalgrowth of ~5%-6%) and China’s second-largest-ever stimulus.

The question is whether the private sector has awoken from its decade-longslumber—and if it has, would productivity and velocity of money rebound,necessitating liquidity withdrawal (otherwise stagflation could loom) with risingcost of capital and a steepening curve, confirming strength. If on the otherhand this ‘recovery’ is essentially an afterglow of CBs and state policies, thenwithdrawing supports would prompt disinflationary pressures to re-appear—and neither demand nor supply of capital could justify higher rates. Hence,attempts to withdraw liquidity and tighten would further flatten yield curves,reduce liquidity and encourage saving rather than consumption. At that point,CBs would need to stop tightening and aggressively manage yield curves.