March Madness in the Bond Market

There was a little March Madness on Wall Street. In fact, the month turned into an old-fashioned blood bath. But you wouldn’t have found any carnage in the stock market. In fact, the Dow Jones gained a decent 2.3% on the month. But beneath that glittery stock market stage (that attracts the most investor attention) there was some chaos in the orchestra pit. The normally sleepy bond market just experienced one of its worst months ever, and one of its worst quarters in over forty years, down almost 7%. The municipal bond market just posted its worst quarter since 1994, down more than 5%.  

Investors who look to bonds for safety and modest returns just received a brutal lesson in the perils of unexamined optimism. But as bad as the losses were, I believe they could have been far worse had investors had a more realistic outlook on future inflation. When they finally figure it out, it’s not just bond investors who may suffer. 

In many ways the bond market acts as both the nervous system and the safe deposit box of the financial world. Borrowing costs and access to capital are fundamental inputs for individuals, corporations, and governments, and those conditions are established in the bond market.

In September of 1981, a 20-year bear market in bonds finally capitulated in a stunning inflation-driven rout that took yields on 10-year treasury bonds to nearly 16%. (In the bond market yields rise when bond prices fall). For a generation prior, people had been selling bonds for less than they had paid, and borrowers had to continually pay more in interest to attract nervous investors who had been spooked by previous losses. 

But after Paul Volcker had finally started restoring some order to the madness, things got steadily better. Despite some relatively minor counter-trend movements, the bond market for the past 40 years has been a warm, happy place where bond issuers have been able to market their debt at increasingly lower rates, and those buyers who then decided to sell always found a long line of new buyers happy to pay more. Generations of investors have come and gone under these benign conditions.