Macroscope | End of US bond rally looms as Fed prepares for rate rises
Central bank is expected to tighten its policy gradually to keep the markets happy while the road to higher treasury yields is about to begin
The 34-year rally in the US bond market is coming to the end of the line. The Federal Reserve might have given the treasury market one final flurry with recent hints that it is in no rush to tighten interest rates just yet, but in the bigger picture, the party is over. A new epoch of higher US treasury yields is about to set in.
This bond super-cycle has seen 30-year US government debt yields crashing to a recent 2.25 per cent low from a peak of more than 15 per cent in 1981, when the bond market was in full flight, thanks to rampant inflation, a weak dollar and a yawning budget deficit.
There has been a lot of volatility along the way, but the trend has led inexorably towards lower yields.
In recent years, bond market bulls have latched on to economic downturn, financial crisis, safe-haven factors, zero interest rates, quantitative easing, deflation and the stronger dollar as reasons to buy the rally. But the bull market is fast running out of excuses to go much further.
Six years of US economic recovery, budget deficit problems, the Fed's bond-buying spree coming to an end and interest rates getting ready to rise all argue that US treasuries are past their sell-by date. Pretty soon, the Fed will have to commit to higher rates and that should be the point where the euphoria in the bond market starts to crumple.
So far, the Fed has succeeded in keeping the markets on its side. It dropped the word "patient" from its rate guidance as a sign that it is returning to rate decisions being made on a meeting-by-meeting basis. And it balanced it off by downgrading its projections for growth and inflation, signalling no rush to push up borrowing costs just yet. The consensus still favours a slow crawl to tightening, with the market betting on an October "lift-off" for rates.