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Kames' Snowden: 'All I want for Christmas is… a bond market sell-off.'

Kames' Snowden: 'All I want for Christmas is… a bond market sell-off.'

I have been thinking long and hard about what’s on my Christmas list this year. So far there’s only one thing that I really want. That one thing, even as a bond manager, is a bond market sell-off.

We all know that bonds have risen inexorably in price since the global financial crisis and as such yields have fallen to historic lows. In a hunt for yield, investors have either left the asset class or travelled further and further across the risk spectrum to satisfy their yield requirements. A healthy sell-off should entice those who have abandoned the asset class back into bond markets.

I’m dreaming of a red Christmas

Apart from bringing a bit of yield back into an asset class that is meant to deliver some income to investors, why would I want to see red across my Bloomberg screen?

Over 2017 to date, the trading range for 10-year US Treasury yields has been roughly 60 basis points, which is the smallest range since 1965. The MOVE index (which measures the volatility of 1-month Treasury options) is at its lowest level in 25 years, while the VIX index, measuring equity volatility, is flirting with its lowest recorded level ever. There is undoubtedly some complacency in markets and a shake-up could be just what the bond market needs.

An injection of volatility lets active managers like ourselves really shine; anyone can make money in a rising market. When markets get volatile and investors have to manage risks carefully, experienced active managers add value for their clients.

From a top-down perspective, global cross-market relative value opportunities will be uncovered by market dispersion – unlocking sources of return that less flexible funds cannot access. A sell-off will remind investors of the importance of bottom-up stock picking, as shaky companies buoyed by cheap access to credit will suddenly find themselves in a tricky spot.

But it looks like we’re destined for a silent night

Things that might ‘rock the boat’ include central bank monetary policy – should it be more aggressive than the market expects. While we don’t see anything drastic from the central banks, this could change if the inflation outlook changes dramatically. Indeed, the market probably isn’t pricing-in enough in terms of rate hikes. Rates could move higher than the market is expecting, given the improving macroeconomic backdrop.

Politics in Europe may not be as settled as the market seems to think. Don’t forget that Germany has failed to form a coalition for the first time since WWII. Could Italy provide some political volatility next year, and remind us all that populism in Europe is not over? Maybe.

And of course some of the things the market is taking for granted right now might just disappoint. For example, US tax reforms aren’t a sure thing, and commodities have buoyed markets this year, but that may not last.

However, as alluded to, this might all just fade into the background and we see 2017 all over again. Given debt burdens and ageing populations it is quite possible that government bond yields will not rise considerably. We could be in a low rate environment for a generation.

But still, all I want for Christmas is a bond market sell-off.

Citywire A-rated Stephen Snowden is co-head of fixed income at Kames Capital.


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