Bonds Take A Hit – Again!

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What's going on?

Government bonds around the world sold off again on Thursday as investors digested further signs of improving economic growth along with central banks willingness to become less supportive of their economies.

What does this mean?

It began last week when the President of the European Central Bank (ECB) made some comments that investors interpreted to mean the ECB would likely take steps to allow interest rates to rise (see here for more background). This week, minutes of recent meetings of the US Federal Reserve (the Fed) and the ECB were released (on Wednesday and Thursday respectively), which also suggested that higher interest rates are on the way.


At the same time, data released this week suggested that the eurozones economy continues to grow at its fastest rate in six years and that the US economy may be improving following a recent soft patch. Since higher interest rates create a headwind for the economy (by making it more expensive to borrow, and thus spend, money), better economic data helps gives central banks the green light to raise interest rates (Why would central banks want to do this? Click here).

Why should I care?

For markets: Bonds are bearing the brunt of the selloff but stocks have wobbled as well.

Investors are selling bonds partly because they think that future bonds will offer them higher interest rates (i.e. cash payments) than the bonds they own today. Meanwhile, stocks are often valued relative to bonds (since investors have a set amount of money that they can typically invest in either one). As bonds go down in price, investors might sell stocks in order to buy more bonds, thus pushing down the value of stocks too.


The bigger picture: This is a very gradual shift away from policies that have been extremely supportive.

If we were discussing gas barbecues, this would be like turning down the heat from max sizzle to a slightly lower level of burning hot. The Fed has been very gradually turning down the heat in the US for a few years now; the ECBs pace of change is unlikely to be any faster.

Originally posted as part of the Finimize daily email.

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