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Global bonds have an active week, surprise investors
Global bond yields rose sharply last week with 10y yields back to their November 2014 levels. Yields on German bunds were 0.07% on 20 April and hit 0.88% midweek, up 34bps in two days. US yields rose 52bps higher than their early April low of 1.84%. UK yields were up 60bps on their late-March lows and French yields followed while Greek yields fell 62bps. The Aus-US spread widened another 5bps to 66bp. The cause of these gyrations are partially explained by the spectre of deflation receding and expectations that the Fed will lift rates this year.
Most Fed-watchers forecast the first rate hike sometime between September and December this year although the IMF’s Christine Lagarde last week appealed to the Fed to leave any rate raising until early 2016. Draghi pointed to disparate reasons for the rout in bonds, including an improving economic and inflation outlook in the euro zone, heavier issuance, volatility and poor market liquidity.
Pessimists point to the fact that asset prices in general are very frothy after central banks around the world have been playing fast and loose with their printing presses and that anything could happen because the market dynamics are virtually unique and there are few precedents to go by. If investors exit bond funds in the same way as they did in 2013 it may cause even more volatility than last time because the Fed is no longer purchasing bonds in vast quantities even though both the European Union and Japan are still buying government bonds.
But in part that is at the core of the problem. With the ECB spending €1.1tn in quantitative easing, much of it on bonds, investors no longer appear to want to hold paper paying tiny yields, given the improving euro zone economic data which point to a brighter futureand the prospect of higher inflation. The ECB is not there to bail out investors. Draghi said he planned to do “nothing” about greater volatility in the bond market and hinted that the debt markets had simply better “get used” to volatility in an era of ultra-low interest rates.
Investors had presumed that euro zone yields would stay low as long as the ECB kept up its bond-buying until at least September 2016 and expected that any economic rebound would be a long time in coming. Draghi, however, accepts that extreme bond market volatility is inevitable and that investors who fails to factor this into their thinking will have some unpleasant surprises ahead.
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