What's going on?
While stock prices are riding high, there is a big selloff occurring elsewhere as investors head into the holidays: bonds are having a rough week!
What does this mean?
Most bonds pay their owners interest in the form of a fixed amount of cash each year. They are, therefore, viewed as relatively safe investments. Safety is attractive in challenging times and a guaranteed fixed return of cash is similarly attractive when investment returns are low – which has, on the whole, been the case since the 2008 financial crisis.
However, the times… they may be a-changin’. Global economic growth is undergoing a synchronous revival. Massive changes to US taxes are about to become law, including a big cut to the corporate tax rate, which will boost companies’ profits. That’s all good for stocks – but bonds are looking relatively less attractive as a result.
Why should I care?
The bigger picture: The stronger the economy, the more quickly central banks will pare back their support (which is also bad for bonds).
Central banks have been forcing down interest rates pretty much since the 2008 financial crisis in an effort to encourage people and companies to borrow, and thus spend, money. Remember, actions that lower interest rates are usually good for bond prices because the guaranteed income that bonds pay is more attractive. But, as those policies reverse, they become a headwind for bond prices. And those policies will reverse more quickly as economies improve and, consequently, there is less need for central banks to provide their support.
For markets: While it’s a sad Christmas for bonds, they actually had a decent year.
It’s important to realize that while bonds have sold off considerably since their highs in August, most types of bonds have still gone up in price this year (or, at least, have only lost a moderate amount of money for their investors). The real question is whether this holiday selloff is foreshadowing a major trend for 2018.