Global bond sell-off: Why investors are heading for the door

The mighty global bond market saw $1.5trn (£1.2tn) knocked off prices last week as investors aggressively looked for value following the wholesale changes in economic policy Donald Trump plans to bring to the White House.

Why are global bond markets falling?

A wave of selling is sweeping across bond markets since Donald Trump was elected US President as investors pile into higher paying investments.

Until the Republican's billionaire's White House victory last week investors had bought bonds, seeking a safe – but low – rates of return during what has been years of sluggish growth since the financial crisis in the US, Europe and Japan.

But now investors are betting inflation and interest rates will rise and want assets with a more attractive return. With the Trump administration promising a $1trn infrastructure programme, increased defence spending and tax cuts, investors are pulling their cash out of low paying assets such as bonds.

What has been the effect?

US and European bond prices have fallen in expectation that Trump will enact inflationary policies that speed up the pace of interest rate rises.

Bonds lost $1.5tn around the globe last week, according to the Bloomberg Barclays multiverse index of corporate and sovereign bonds.

But the effect of the bond sell-off is much more severe on emerging nations, which has seen the yields on their dollar-denominated paper soar. In an environment of rising inflation, lifting interest rates and a strengthening dollar the debts of emerging nations will become more expensive.

Mexico, Brazil and Argentina have all seen the price of buying their long-term debt fall sharply and yields jump, reflecting new perceptions of risk.

Over the same period New York's Dow Jones Industrial Average hit all-time intraday high of 18,873.6 and London's FTSE 100 Index made strong advances as traders bet that defence and construction firms will benefit from what the incoming President promises to do.

We are in the middle of investors aggressively searching for the best prices between between bonds, emerging markets, the dollar and equity markets, analysts point out.

But European Central Bank vice-president Vitor Constâncio warned earlier this week in Frankfurt that Europe could suffer alongside emerging countries as a result of US protectionism.

Constâncio said: "We should be cautious in drawing hasty, positive conclusions from those market developments because they may not necessarily indicate that the world economy will have an accelerating recovery with higher growth.

"So far, those developments point to a US rise in economic growth, but in the context of an 'America first' policy."

Can the bond market affect governments?

Certainly. If bond market investors think that a government's policies are going off track and there is an increasing risk that they won't be repaid, they sell bonds, driving up the yield. That in turn makes it more expensive for the government concerned to borrow money when they next have to.

It can lead to a vicious spiral of rising borrowing costs, which in turn makes the debt even less sustainable. The end result can be a default, or perhaps an international bailout.

There have been many defaults over the centuries. Argentina in 2001 was a relatively recent example. The country's more recent default, in 2014, was rather different. It was the outcome of a legal dispute with some bondholders, rather than being unable to pay.

James Carville, an American campaign strategist for former President Bill Clinton, famously said in 1993 that if reincarnation was real, "I want to come back as the bond market. You can intimidate everyone."

How much is the bond market worth?

It's huge. Calculating a specific figure is not straightforward and it does change as markets move. The McKinsey Global Institute published some figures in 2011 which put the outstanding amount of bonds (depending on what exactly you include) at more than $100 trillion (£76tn).

The whole bond market at the time was, according to these figures, worth about double the value of global shares.