Why Have Bond Prices Suddenly Fallen?
The last few days have a seen a rout in the bond market… Why? What does it mean?
Very briefly, the market sees Donald Trump’s policies thus:
- Fiscal stimulus from lower taxes and increased government spending on infrastructure etc., will massively increase the need for US government borrowing. Couple this with increased protectionism on imports, and you have significant inflationary pressures. On top of this, there is a still a fair chance of the Federal Reserve raising interest rates in December.
- In times of rising inflation and interest rates, bond yields rise. The expectation is that new government borrowing (selling bonds) will need to be at more attractive yields than currently on offer. This forces the market price of currently issued bonds downwards, because the price of an existing bond must reflect the option of the bondholder to sell and trade in for new bonds that have a higher yield.
- Hence we see bond prices plummet as the market ‘prices in’ the prospect of higher government debt, inflation and interest rates.
- For the average investor, this presents a great lesson in why it can be a good idea to invest in bonds via a diversified portfolio of well-managed bond funds. A mix of managers, with a mix of strategies, addressing a mix of bond classes and geographies, helps mitigate volatility and brings the potential for capitalising on opportunities that arise.
(First Posted November 2016)