Global Equity Strategy: Bonds: What if?

Research evidence excerpt

Global Equity Strategy: Bonds: What if?

BO estimates the US government debt to

GDP rises to 156% of GDP by 2055 on current trends); iii) the US inflation breakeven at

2.2% (5 year-5 year forward) implies the Fed will hit their inflation target despite missing

it for the past 5 years; iv) the US yield curve (2 to 10 years) is only mid-range; v) the

bottom-up push from Japan (where 3% wage growth likely causes rates to rise faster

than those implied by the forward curve) - by 2028, the BoJ's holding of JGBs is forecast

to decrease from 49%to 36%; vi) funding: central banks at peak owned 30% of

government debt - now it is 20% - and a rise in yields increases the switch from Defined

Benefit to Defined Contribution which leads to selling (e.g. in the Netherlands, the

change resulted in €250bn of selling of the 10-year equivalent); vii) above all, the 60/40

portfolio is now vulnerable - bonds have not hedged into the three recent equity sell-offs

(bond yields rose as equities initially fell post Russia's invasion of Ukraine, Liberation Day

and initially into the Middle East crisis). Bonds do not hedge if there is an inflation shock

or if into a growth shock governments resort to sharp fiscal easing. For the vast majority

of the past 300 years in the UK, we note that the 60/40 portfolio has not worked.

Hence, this raises questions about the diversification merits of bonds.

When do rising bond yields pose a problem for equities?

The bond to equity relationship has been very unstable - with this caveat in mind, our

models highlight the potential risk level is c5.2% on the 10-year (assuming Gen AI can

increase productivity growth by 2% from 2028 and credit spreads rise to 3.2%). Into

bubbles, equities typically peak when the 10-year bond yield is in the 5.5%-6.5% range.