The sell-off starts? Bonds suffer fourth-worst month in 20 years

Concerns over a potential end to US quantitative easing saw global fixed income markets slump in May, but further sudden sell-offs may be less likely.

The Bank of America Merrill Lynch Global Bond Market Index fell 1.5% last month, its largest loss since April 2004, with ‘safe haven’ sovereign debt particularly affected.

In the US, investors beginning to position for an eventual ‘tapering’ of quantitative easing pushed yields on 10-year treasuries from around 1.9% to as high as 2.2%, with benchmark debt losing 3.3% over the month as a whole.

The UK market saw 10-year gilts shed 2.3% in sterling terms last month, as expectations of further QE in the near future declined, while concerns over ‘Abenomics’ saw Japanese 10-year yields rise from 0.3% to 1% on the month.

According to J.P. Morgan analysts, the only ‘materially’ worse months for the global bond market in the past two decades were February 1994, when the Federal Reserve surprised investors by raising rates, and the fallout from the ‘VaR shock’ seen in Japan in July 2003.

Those analysts also noted that bond ETFs in the US saw their largest weekly outflow on record last week, at $1.5bn, but they are skeptical over the prospect of a further sell-off.

“We estimate that a rise of 100bp in yields [from early 2013] would be required to prompt material selling of bond mutual funds. The 30bp rise in yields over the past month, coming on the back of a previously solid YTD rally, still falls some way from meeting that mechanical threshold.

“Bond positions are likely not supportive of a further sell-off.”

Barclays’ global macro team also said investors may be getting ahead of themselves in anticipating Fed tightening, though they suggest May 2013 may eventually come to be seen as an “inflection point” in the present era.

“Even in the US, which seems likely to lead the way toward normal monetary conditions, there is at the moment almost no reason to fear that the monetary authorities will feel under pressure to act soon, or abruptly,” the team said.

Howeer, given current correlations between global bond markets’, Barclays notes the “worrisome” potential for contagion from an eventual tightening in the US meaning “tighter financial conditions in regions less prepared for it”.

Expectations of such moves have been brought forward in recent weeks. The ‘tapering off’ of the Fed’s QE programme, while conditional on further improvements in the unemployment rate, is now expected to commence towards the end of this year.

CME futures contracts, meanwhile, suggest almost one in three investors now expect a fully-fledged rate hike in the US by mid-2014.


This article was first published on Investment Week


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