Parties rarely last 30 years, but the one that the bond market threw did.
Over the past 30 years, bonds have enjoyed outsized gains, but the celebrating among fixed-income investors has quickly ended.
In April, Bill Gross, an investment manager at PIMCO and probably the nation’s most widely known fixed-income expert, turned to Twitter and announced the end of the 30-year run in a Tweet.
The real move, however, started in May and June when many investors began exiting the bond market. The prospects of rising interest rates encouraged investors to withdraw an estimated $60.5 billion out of bond funds in June. These fixed-income withdrawals were 47% greater than in October 2008 during one of the nation’s worst financial crises, according to the Investment Company Institute, a mutual fund trade group.
Scared investors were reacting to comments that Federal Reserve Chairman Ben Bernanke made to Congress and later to reporters in June.
The chart below from the U.S. Treasury illustrates the sharp move up in interest rates as fixed-income investors began selling in response to Chairman Bernanke’s comments:
One of the primary market developments that spooked bond investors was the prospect of rising interest rates as the Federal Reserve begins to taper its bond-buying program. Bond investors fear interest-rate increases because they depress the value of the bonds that they currently own.
Who would want a bond, for instance, paying 2% if new issues are now offering 3%? Investors who desire to unload older bonds in a rising interest rate environment must sell at lower prices.
In contrast, when interest rates are dropping, an older bond will be more valuable because it offers an interest rate that is higher than what investors could obtain with new bonds.
A major reason why the bond market has enjoyed such heady returns for so long is because interest rates have been on a long decline since the 1980s, when they spiked.
You can see from the following chart that the yield on the 10-year U.S. Treasury note peaked in the early 1980s and has since fallen steadily: