The last few months have seen some dramatic changes. Lots of attention has been paid to the Trump team line up; much political capital spent on Britain’s Brexit Bill being pushed through the UK Parliament. Given these events along with upcoming European elections, you would expect the bond market to be experiencing unprecedented volatility. But you would be wrong. Since mid-November the 10-Year US Treasury has traded in a range of 30 basis points – eerily similar to the UK’s 10-year Gilt as well as Germany and Switzerland’s benchmark issues. Likewise, the ‘term structure’ of yield curves for 30-year bonds compared to five or 10-year bonds for all these major markets are not dramatically different.
Also cross market valuations are not distinctly different over the last three months. European markets (Germany, UK and Switzerland) have become a little more expensive compared to US treasuries.
So what are the bond markets telling us? They are reminding us that they are forward looking and efficient. With 10-year US treasuries priced at 2.45% and 10-year Gilts at 1.3% all the action was in the previous three months. That action was driven by Brexit and Trump – with neither event anticipated by markets.
Thus, bond markets rapidly assessed a material change in outlook; Gilts almost trebled in yield from mid-August to November with a logical and unemotional assessment of higher inflation and further political challenges for the UK. Likewise, for the US, expectations of Trump shaking the political tree in Washington were rapidly priced in the days after his election. For Europe a similar story, Bunds were unchanged over this period but political stress signals are starting to be priced into the valuation of French and Italian bonds.
So what are the bond markets missing? Not much bar the politics – witness the underperformance in French bonds. Expect volatility if populism really does become a European phenomenon; Wilders in The Netherlands and Le Pen in France are still regarded as unlikely winners by markets but swathes of people voting for them can readily change that.
But the central case is that Europe rattles on with the European Central Bank in the driving seat. Slightly higher inflation and moderate growth across the EU, Switzerland and US are what the bond markets are currently expecting. However, a political shock from Europe has the capacity to shake the bond market from its current complacency.