A just-published report updated our view that DM government bond markets and central banks have been mirroring the macro environment of the 1980s, only in reverse. Understanding the evolution of investor perceptions and bond market pricing during that decade, when the secular inflation trend was reversing, has already proven valuable for investment returns in recent years, and we expect it to remain helpful going forward.
The Fed et al and bond investors were initially extremely hesitant to abandon the macro framework from the inflationary 1970s. Disinflation was viewed as “transitory” for much of the 1980s, similar to the current period where the consensus still views inflation above 2% as being a temporary phase. As occurred in the 1980s, albeit in reverse, bond yields could briefly drop more than justified whenever measured inflation subsides, as is currently the case. Nevertheless, while tactical bullish bond bets will periodically perform well, the structurally backdrop is bearish.
After four decades of disinflation and then flat-flation, it will take a long time for inflation expectations and bond yields to reflect today’s different inflation backdrop. Still, the buy-and-hold era for bonds has ended, and a profoundly different investment mindset will be necessary to prosper, or to at least avoid persistently underperforming.