The decline observed in the bond market is directly linked to the sharp rise in inflation recorded over the past two years, which has led to sustained increases in interest rates that banks central measures have decreed precisely to slow down this surge in inflation.
When interest rates rise, the yield on bonds falls, and therefore their value. If you purchased a Canada bond with a 5-year term at a 3% yield and rates increase to 6%, the value of your bond will decline because it has less market appeal than new bonds that are put into circulation with a higher rate of return.
This drop in value will be realized if you sell your bonds before their maturity date, their market value will drop enormously, but the 3% return will not be altered if you hold them until the end of their term.
“We then talk about a relative loss,” explains Jocelyn Paquet, economist at the National Bank. You will obtain your return of 3%, with your Canada bonds, but it will be lower than that of the market which is 6%.
“There may then be problems matching your portfolio if your 3% return was used to pay off your 3% variable rate mortgage and it suddenly goes to 6%. Otherwise, it is a relative loss compared to the market. »
Generally, people who buy bonds buy protection against inflation and this function completely disappears when you have a bond which guarantees a return of 2% and inflation is above 6%…
However, the fact that the bond market declines at the same time as the stock market declines, as is currently the case, does not constitute a historical precedent.
Alexandra Ducharme, also an economist at the National Bank, notes that such simultaneous declines in the value of bonds and that of stocks have occurred in the past, notably during the 1960s and at the end of the 1990s, both categories of assets that generated negative returns.
“This happens when we experience a dual context of high inflation and slow economic growth. High inflation leads to a rise in interest rates which negatively affects the value of bonds while economic growth which slows or declines negatively affects the stock market,” notes the economist.
We therefore understand that the drop in inflation and the reduction in interest rates are the main factors which will allow the bond market to recover and start generating more attractive returns.