(Bloomberg) - The question of the day is whether we’re in a bond bear market. After all, we don’t even know what one looks like.
I was on record a month ago saying 2022 would see a prolonged downturn. So, I think the answer is yes, we seem to be in a bond bear market. That means there are two important episodes to keep in mind now: The 2013 “taper tantrum,” and the bond market massacre of 1994.
My interpretation of the taper tantrum is that bond markets were getting in front of an anticipated tightening in U.S. monetary policy, causing yields to spike and the weakest emerging markets to suffer. But, in 2021, when the Fed first started talking about tapering, it explicitly said there was no discussion around rate liftoff. So front running hikes via a “taper tantrum” didn’t make sense.
That changed late last year. In early December, I said that a taper tantrum was on the table for 2022, centered in credit and emerging markets. And we have already seen the initial selloff in credit. But, despite all the headlines and angst, things are tame so far. We’ve seen worse, even in the last few years, namely in December 2018 and March 2020. It will only become a “tantrum” if the Fed further accelerates rate hikes.
Then there’s 1994.
That year was a lot worse for developed markets than the taper tantrum. The Fed was more secretive back then, and totally surprised markets by jacking up rates soon after the slow, so-called “jobless” recovery ended. Friends of mine found offers from investment banks were suddenly rescinded. And people were getting sacked in droves on Wall Street and in the City of London. It was a very ugly period in bond markets and for job security.
But, if you look at Treasury markets, the ten-year path tells four stories.
First, just like in 2020, there was massive monetary easing as 1991 began. Commercial property and high-yield markets languished, and the clean-up after the disastrous Savings and Loan (S&L) crisis was underway. Ten-year Treasury yields dropped three percentage points during that time.
Then -- just as in 2022 -- in 1993, policy changed overnight. But back then, the Fed didn’t telegraph forward guidance, causing ten-year yields to move up almost back to early 1991 levels. That’s a massive amount of tightening and not analogous to the taper tantrum.
Third, bond market carnage doesn’t mean recession. The Fed subsequently pivoted and yields came right back down. By 1996, we were 2.5 percentage points lower on the ten-year. That set the stage for five back-to-back years of 20%+ gains for the S&P 500 Index, and then for the equity bubble that later grew out of those gains.
Lastly, if you look at spreads, despite the decline in yields after 1991, there was a massive curve steepening. That helped banks rebuild capital, which aided recovery via credit supply. But notice that, when the Fed crushed the bond market in 1994, duration spreads collapsed and didn’t recover for the rest of the decade.
The moral of the story is that, while we’re having another bond bear market in 2022, it doesn’t have to end in a big crisis or recession. The taper tantrum was less destructive for developed markets than what occurred in 1994. And even in 1994, the U.S. avoided recession and went on to stellar growth for the rest of the decade. But of course, not all bond bears are created equal.
By Edward Harrison
