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Are developed bond markets dying?

Weekly investor research

21 November 2016

Developed bond markets are in danger of dying. The end of a 35-year rally in developed market fixed income may be more than just the death of positive returns as inflation risks push up bond yields. There is also a material risk that markets themselves may eventually be relieved of their traditional roles of determining term yields. The reason is that no developed market country is likely to handle the bear market steepening that would occur if markets were free to price bonds as inflation returns. Inflation and currency depreciation would decimate developed market bonds. Meanwhile, the conditions that could usher in the death of developed bond markets simply do not exist in Emerging Markets (EM). This means that EM fixed income markets could soon be the only freely tradable government bond markets in the world. In the global backdrop section we discuss the recent Dollar rally, which has been far more pronounced against EUR and JPY than against EM. In sharp contrast with the current market consensus we do not see great upside for the USD versus EM currencies, because real effective exchange rates strongly point to major upside potential for EM currencies, while inflation could hurt rather than help the Greenback.

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