Why have bond markets been exceptionally volatile while stock markets were quieter at the start of the year?
Host Jessica Schwarzer opens the episode by noting the volatile start to the year in bond markets compared to quieter stock markets. Guest Dirk Steffen, a Deutsche Bank strategist, confirms bond market unrest has persisted since 2022 and is unlikely to calm soon. He highlights a key puzzle: long-term US Treasury yields jumped from under 4.2% to nearly 5% despite a broader context of anticipated interest rate reductions. Steffen explains this rise in yields affects stock valuations through a discounting mechanism where higher yields make shares less attractive relative to bonds. He then breaks down how bond returns are calculated, emphasizing that investors should focus on yield-to-maturity rather than the coupon rate. The discussion shifts to specific market drivers, starting with robust US economic data and inflation figures that initially pushed yields higher before a slight retreat. Steffen details how AI-driven hedge funds targeted UK gilts, recalling the 2022 mini-budget crisis, though he argues the UK's budget deficit and inflation challenges are common across many nations. He also covers political uncertainty in France post-European elections, leading to higher yields on French government bonds compared to German bunds. The conversation turns to the concept of the term premium—the extra yield for holding longer-dated bonds—which has returned after years of being negative due to central bank policies. Steffen challenges the idea of bonds as a 'safety cushion,' noting they caused significant losses in 2022 and remain volatile. However, he asserts bonds now belong in most portfolios because yields of 3.5% in the Eurozone and 5.5% in the US are compelling. He recommends investment-grade corporate bonds as the core allocation, cautioning that high-yield bonds are a niche, riskier market. The episode concludes with Steffen summarizing that quality bonds are currently the most interesting asset class, with currency exposure depending on overall portfolio structure.
