Taper Tantrum to VAR Shock: When the Next Bond Rout Is Coming

Cast a gaze across global bond markets and it’s a sea of calm. Yields are close to record lows, volatility is nowhere to be seen and central banks are still ploughing trillions of dollars into the economy to help foster a recovery.

But even in this new post-pandemic world, investors risk getting caught wrong footed. The International Monetary Fund’s chief economist Gita Gopinath warned last week of stretched asset valuations, saying investors are pricing in the best-case scenario when it comes to the trajectory of the coronavirus crisis. And any hint from authorities that monetary policy may not remain as easy, could spur turmoil across markets. Just look at how fast yields have moved higher in recent weeks on even the whiff of inflation.

From the U.S. taper tantrum in 2013, to the VAR-shock in Japan a little under two decades ago, here’s a glance at some of the blips in the multi-decade bull market in bonds, and what it might mean for the future.

Inflation Fear

As always, the number one danger is inflation, which erodes the value of debt as it accelerates. That’s especially true today, since duration -- a measure of how sensitive a bond is to rising interest rates -- is near record highs in corporate debt markets. In Europe, governments have been ramping up sales of longer-dated bonds, the most exposed to a pick up in consumer prices.

What’s more, over $16 trillion of debt now yields less than 0%, leaving holders with little wiggle room if the outlook shifts. For Alessandro Tentori, chief investment officer at Axa Investment Managers, that’s adding to an already-explosive cocktail of risks that plague the market, including a dearth of liquidity after years of hefty central-bank bond buying.