Bill Gross warns of bear market in government bonds

If U.S. 10-year bond yields rise above 2.6%, it will mark the beginning of a prolonged bear market in government bonds. Previously Warns asset manager Bill Gross, who worked for Pimco for many years and is now active at Janus Capital. According to him, the development of interest rates on government bonds is now much more important than what happens in the stock market or the foreign exchange market. In his latest newsletter for clients, he writes the following:

"Keep a close eye on the 2.6% level. This is much more important than the Dow Jones at 20,000 points, much more important than an oil price that breaks through $60 a barrel and much more important than parity of the exchange rate between the euro and the dollar. It will be decisive for interest rates and possibly also for share prices in 2017."

The yield on so-called 10-year Treasuries already came close to the 2.6% level in December, but at the time of writing, the yield is lower again at 2,35%. Since Donald Trump's election, yields on debt have risen rapidly as investors expect Trump's fiscal stimulus to boost inflation.

"Since November , a strong sense of optimism has dominated the equity market, while there has been a sense of despair in the bond market. Are stocks now overvalued and Have Treasury yields overshot? That's the critical question for 2017."

Interest rates on US 10-year bonds have risen sharply (Source: Bloomberg)

Interest Rates vs Inflation

Since Trump's victory, investors have been anticipating more economic growth, which will benefit companies. Investors expect the profitability of publicly traded companies to increase, justifying a higher price. More economic activity can also lead to more inflation, which is unfavourable for the bond market.

Interest rates are already exceptionally low, which means that the effective yield on government bonds quickly becomes negative when inflation rises. Historically, there has been a very strong correlation between the real interest rate and the price of gold, namely that the price of the precious metal reacts positively to a period in which inflation is higher than interest rates. We may be on the verge of a new period of stagflation, characterised by weak economic growth and rising inflation.

Rising inflation worries bond investors, is gold a safe haven? (Source: World Gold Council)