End of 30-year bull run for bonds sparks record capital outflows from emerging markets

Last month’s shock election of Donald Trump as US president sent global bond yields skyrocketing, prompting a widespread view that the 30-year bull run in debt markets is finally at an end.

Emerging market bonds, which had benefited from investors’ appetite for yield in the past, have been left reeling by a tidal wave of capital outflows.

The yield on the benchmark 10-year US Treasury bond, which moves inversely to its price, hit 2.39 on Tuesday after peaking at 2.45 per cent last week, after data showed that the pace of growth among domestic services industries accelerated faster than forecast in November.

The two-year Treasury yield increased to 1.12 per cent and the 30-year yield rose to 3.08 per cent, after hitting its highest level in 13 months on Monday.

The picture is the same in other developed economies. The yield on Japan’s 10-year government bond rose to 0.05 per cent on Tuesday, the highest level since mid-February, while the yield on UK 10-year government bonds climbed to 1.43 per cent earlier this week, similar to the level seen before the country’s decision to leave the European Union.

“We are possibly seeing the turning point for a 30-year rally in bonds across developed economies,” said Shen Jianguang, managing director and chief economist of Mizuho Securities Asia Limited.

This view was echoed by Hong Hao, managing director and chief strategist at Bocom International in Hong Kong.

“It’s very likely that the yield on the benchmark 10-year Treasury bond has bottomed, after falling for 35 years,” said Hong in his recent report.

Emerging markets, which had been attractive for investors with their relatively high yields, have witnessed large-scale capital outflows over the past several weeks.

“We are seeing fund flows moving back to developed markets as their bonds are surging,” said Neeraj Seth, the head of Asian Credit at BlackRock’s Asia Pacific Active Investments Group. “The trend was already in place ahead of the election results and the US election accelerated it.”

Xie Yaxuan, chief macro analyst at China Merchants Securities (Hong Kong), said: “Capital outflows from Taiwan and India intensified last week to the highest level this year, and South Korea and other Asian economies are also seeing outflows accelerate.”

According to Bank of America Merrill Lynch, capital outflows from emerging market bonds amounted to US$6.64 billion during the week, the largest on record going back to 2009. Government bonds saw a US$1.18bn outflow following a US$1.36bn inflow in the prior week, according to the bank.

As capital outflows accelerated, the Asian Currency Index and Emerging Market Currency Index fell by 3.9 per cent and 1.9 per cent respectively last month, a decline last seen when the Federal Reserve raised interest rates in December 2014.

The surging yields are seen by many as being a response to higher inflationary expectations, with the world economy apparently preparing to shift from a growth model driven by monetary easing to one based on fiscal expansion.

The fiscal expansionary policies promised by President-elect Donald Trump, including tax cuts and massive infrastructure spending, will lead to higher inflation in the US, said Shen Jianguang.

“Inflation is rising and it’s been underestimated,” said Hong. “The ECRI US Future Inflation Gauge shows that inflationary pressure has reached the highest level since 2009.”

A report released by Morgan Stanley said: “Looking ahead, fiscal policy looks set to play a more active role in the US, Japan and the UK.

“In a number of countries, notably the US and the UK, inflation will be moving towards and possibly even above the central bank target over the forecast horizon.”

However, some analysts warned that the recent surge in bond yields may be overdone to some extent.

“There could be a potential for yields to rise a little further, but having run so fast recently, we think there is some space for some short-term correction before a slower climb,” said Irene Goh, the head of multi-asset solutions, Asia Pacific, Aberdeen Asset Management.

“Trump’s proposed tax cuts appear to be unfunded at present and the possibility of future spending cuts to pay for the tax measures may begin to loom larger in markets’ minds over time.

“Markets have gone from horror at Trump’s victory to giving him almost a free pass in the space of days, and that makes little sense.”

BlackRock’s Seth said: “The end of a bull market [for bond prices] does not necessary mean the start of a bear market and there could be a phase in the middle for a while.

“The forward trajectory might not be as sharp,” said Seth, after “the 10-year Treasury yield has risen about 90 basis point in the last few months since it bottomed back in July.”

Despite the market consensus that a turning point has been reached, the governor of the Swiss central bank said recently that it is still too early to talk about a reverse. Negative rates remain at the centre of monetary policies and expansionary policies still suit the current economic situation, he said.