The Story Behind the Global Bond Market Rout—and Whether It Will Continue Into 2023

Traders work on the floor of the New York Stock Exchange during morning trading in New York City, on Sept. 6, 2022. Michael M. Santiago/Getty Images

It has been a year to forget for global financial markets, and there’s still another quarter to go in 2022. While stocks have captured most of the selloff attention this year, even safe-haven assets have plummeted, including the international bond market, which has experienced its worst performance in several decades.

According to Bank of America analysts, global bonds slipped into a bear market for the first time in 73 years after tumbling by about 20 percent from their peaks.

Investors have been ditching everything from U.S. Treasurys to UK gilts to German bonds. Global bond market indexes have slumped year-to-date, such as the Vanguard Total World Bond ETF (down 14 percent), iShares Global Govt Bond UCITS ETF (down 20 percent), and Invesco Total Return Bond ETF (down 18 percent). The Bloomberg Global Aggregate Bond Index (unhedged) is down by about 15 percent from its January 2021 high.

So, what’s causing this international market mayhem? It all traces back to central banks.

The Story Behind the Selloff

The most significant contributing factor in this year’s bloodbath in global bonds has been monetary policy-tightening efforts by central banks, whether the Federal Reserve or the Bank of England. Traders are anticipating higher interest rates as these institutions worldwide combat elevated inflation. As investors price in higher rates, they’ve sold government bonds at a rapid pace, sending yields to levels unseen in years.

Typically, surging yields and falling prices should indicate less demand for bonds because investors are flocking to high-risk assets. Instead, most financial markets are tanking as the U.S. central bank aggressively tightens and economic conditions weaken in the European Union and the UK.

A picture illustration of a $100 U.S. dollar bill, a Swiss franc, a British pound, and a euro banknote, taken in Warsaw, Poland, on Jan. 26, 2011. Reuters/Kacper Pempel/File Photo

“What makes this current period even worse historically is that we are now seeing deep losses in nominal terms which, for many countries, has never previously happened over a sustained period outside of wars or defaults,” Deutsche Bank researchers Jim Reid, Henry Allen, Luke Templeman, and Adrian Cox wrote in a research note.

The benchmark U.S. 10-year yield briefly topped 4 percent on Sept. 28 for the first time in 12 years. Last week, the 2-year Treasury yield also rose above 4.2 percent, to its highest level since August 2007.

“The markets are showing a healthy respect for Fed hawkishness, even after inflation weakened in the past two inflation reports. There is some optimism that the current rate-hike cycle is reaching its end,” Kenny Fisher, a market analyst at OANDA, wrote in a note.

Overseas, the U.K. government bond market has been extremely volatile this week as yields have increased, from short-term maturity to longer term-dated debt instruments. UK gilt yields have been on track for their largest monthly spike since 1957. The 10-year gilt yield soared by about 20 basis points on Sept. 29 to about 4.21 percent.

It was so chaotic in the UK that the Bank of England (BoE) had to intervene by pausing its bond sales and now plans to temporarily buy long-dated UK government bonds to “restore orderly market conditions.”

“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy,” the Bank of England said in a statement.

The selloff occurred after UK Prime Minister Liz Truss announced a so-called mini budget to support economic growth and prevent a recession. Market analysts were quick to point out that this would prevent the central bank from achieving its new objective of reining in rampant price inflation.

But British central bank chief Andrew Bailey’s decision to intervene led to speculation that other central banks could emulate the BoE and pivot.

“If growth fears don’t stop central banks, systemic risks could,” ING strategists Benjamin Schroeder, Antoine Bouvet, and Padhraic Garvey wrote in a Sept. 27 note. “Markets, however, are showing more signs of concern over systemic stresses as monetary policy reins are further tightened across the globe.”

An Extended Bloodbath Next Year?

Can investors expect this type of landscape heading into 2023?

According to Quentin Fitzsimmons, a senior portfolio manager at T. Rowe Price, bond market conditions will reverse, citing possible signs of peaking inflation and growing global recession fears. If the former is true, investors will begin seeking real (inflation-adjusted) returns on their investments. If an economic downturn transpires, save-haven demand could be resurrected.

“Having battled with anemic yields for so long, the sharp jump in rates this year will likely spur strong demand from insurance and pension funds,” Fitzsimmons wrote in a note. “With a positive funding status, many institutions will now be looking to lock in the recent spike in rates to offset longer-term liabilities.”

Steven Jon Kaplan, CEO of True Contrarian Investments, thinks investors will eventually return to safe-haven assets, such as government bonds and precious metals.

“My basic theory is that in all true bear markets, stocks and bonds at first go down together, along with gold and many other assets. But afterward, investors gradually differentiate and start aggressively buying safe havens, including federal government bonds, gold, silver, and related assets,” Kaplan told The Epoch Times. “This process of differentiation usually begins after a half year to one year into the bear market, which began on January 4, 2022, and which may last about three years altogether.”

He noted that this pattern has occurred three times before: 1929, 1973, and 2000.

The next test for the global bond market might happen on Sept. 30, when the August Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge arrives, is released. The PCE price index is forecast to dip to 6.2 percent, while the core PCE price index, which excludes the volatile food and energy sectors, is expected to edge up to 4.7 percent.