Unwinding The Valuation Distortion In Government Bonds – April 25, 2022



A just-published report examined how the bond bear market will likely play out in the coming years. We see recent market action as the beginning of a major capitulation by both central banks and bond bulls, and is typical of what occurs during a significant structural trend change in an asset class.

A perfect storm of complacency, faulty frameworks, and unsustainable policy distortions led to the extreme mispricing of government bonds in recent years, along with the denial that macro forces were structurally shifting. Despite the recent capitulation, the Fed and bond investors still remain fairly sanguine in terms of their long-term inflation view, and we expect policy rates to eventually rise substantially above still-depressed estimates of the equilibrium rate.

The valuation distortion in government bonds should unwind with yields moving up in a series of waves. Although there is a risk that investors will riot and rush for the bond exits, a consolidation is more likely before the next major upwave develops now that the selloff has become technically stretched. However, we advise against trying to play countertrend moves, and remain positioned for higher bond yields over time.

 







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