National Post (National Edition)
STILL WAITING FOR THE GREAT ROTATION
BONDS WAVER
It’s a term that these days seems to have fallen to the wayside in financial circles: the Great Rotation.
Back in 2012, when expectations were that higher interest rates were just around the corner, many fund managers talked about preparing their clients for the Great Rotation: money leaving bonds and pouring back into equities.
After all, in the years after the financial crisis, bonds were the big winners as investors sought safety and stability from a world awash in volatility.
But anyone who heeded that advice ended up missing one of the most profitable bond rallies of our time.
After the events of the past week, a lot of investors are wondering whether that rally is over.
Bank of America Merrill Lynch on Friday called the recent stampede out of bonds, which saw US$18 billion pulled out by U.S. investors alone in the past week, a “violent rotation.”
The bank notes that there was a record inflow into exchange-traded funds that focus on stocks this week — to the tune of US$28 billion — the biggest inflow in two years.
“Forgive those on fixed-income desks for looking a bit shell-shocked, because it’s been a tough two weeks for bonds,” said Avery Shenfeld, chief economist for CIBC World Markets.
To be fair, investors have seen this before. In 2013, the U.S. Federal Reserve announced it would soon be ending its third round of quantitative easing, dubbed QE3, which had propped up the bond market with billions of dollars of monthly asset purchases. Investors scrambled for the exits immediately after the announcement.
That bond market rout then was more intense than the current one (at least for now). Yields on 10-year treasuries touched three per cent on two separate occasions in 2013, a level rarely seen in the post-financial crisis world.
The Trump rout has been a little kinder. Yields on the 10-year are currently hovering around 2.3 per cent, but that’s still an extraordinary jump considering that yields were at 1.6 per cent only two months ago.
Sustaining a true Great Rotation still has a long way to go, points out Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch. He was the strategist who originally coined the term in 2011 and has had to spend the past six years waiting for it to materialize. Hartnett points out that in the past decade, a monster US$1.5 trillion has flowed into global bond funds in the U.S. In comparison, when looking at mutual funds and ETFs, the fund flows for equities is a disappointing zero.
The recent stampede out of bonds was triggered by the election of Donald Trump, who has promised a wave of fiscal spending and tax cuts that have economists repricing inflation expectations. There are also questions around whether current expectations about Fed rate hikes need to be adjusted. The market expects a rate hike at the Fed’s meeting next month, but projections do not see many hikes in the next two years.
Shenfeld at CIBC notes that when comparing current bond yields to inflationlinked securities, it looks like bond markets are currently pricing in a 10-year breakeven inflation rate of two per cent.
“That hardly sounds like the bond market is excessively worried about inflation at this point,” he said.
Citi agrees with that assessment. Analysts there say that the recent spike in bond yields doesn’t necessarily signify fear of impending hikes. The market is instead now aligned with forecasts from economists, who call for gradual hikes until 2018.
“While we do not disagree with the repricing of 2017 Fed hike expectations, we are not convinced that the prospects for a yet-to-bedetermined fiscal stimulus should compel the Fed to be pre-emptively more hawkish,” Citi analysts said.
So while a lot of the gains in the bond market may be behind us, it’s clear with current projections, the Great Rotation may still take a while to get here.