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After years of declarations that the bull market in bonds is over and the rise in interest rates was imminent, are we finally there? The move in rates on 10 year Treasuries again prompted this question in the first quarter; rates rose by over 50 basis points during the quarter, before settling in to a more modest 30 basis point increase.
If we are, in fact, at the end of the bull market, what does the new horizon look like? Unlike, we suspect, how equity managers would react to the “end of the bull market”, we welcome such developments, even if we retain some of our skepticism.
Welcoming a bear market?
Why might a bond manager be pleased with higher rates, given that an increase in rates means a decline in bond prices?
In examining the history of returns in fixed income during what has been termed a thirty year bull market, several points emerge which complicate the accepted narrative. It is completely accurate to observe that rates have fallen precipitously from the early 1980s; 10 year Treasuries peaked at 15.84% in September 1981 and ended the first quarter of 2018 at 2.74%. This decline in rates contributed a seemingly impressive 60% to the total return of bonds during that time. However, during the same time, coupons contributed over 1,500%, dwarfing the impact of price return. So, while it is accurate to refer to the period as a bull market, the price return is nearly immaterial to overall returns.
While the lion’s share of the positive returns were driven by coupons, even the consistency of that decline in rates feels overstated in popular literature. Starting from that peak period, yields have actually increased in 14 of the 37 years, or 45% of years.
The fear associated with yield increases is somewhat overstated, both due to the surprising frequency of yield increases as well as the relative paucity of actual negative return years for fixed income broadly, with only three such incidents (1994, 1999 and 2013) since 1981.