The global bond market selloff has erased all of this year’s gains as historic market moves from Germany to the U.S. and Japan whipsaw traders.
After being up as much as 2.3 percent as of mid-April, the Bank of America Merrill Lynch Global Broad Market Index of bonds with a total face value of $41 trillion is now down 0.4 percent for the year.
Bond traders have been caught off guard by signs the worldwide economy is likely to avoid mass deflation and by improvement in the euro zone’s economy, leaving little incentive to own debt securities with yields that in some cases are below zero. The latest leg lower in bonds came Wednesday, when European Central Bank President Mario Draghi said investors should get used to the heightened volatility they’ve seen in recent weeks.
“This is sheer panic in the market from the standpoint of what’s been happening in Europe,” said Thomas di Galoma, head of fixed-income rates and credit at ED&F Man Capital Markets in New York. “Most of Wall Street is guarded here as far as taking on new positions.”
Like many of his peers around the world, di Galoma said he has had to cancel meetings as yields rose ever higher through key levels that many thought would attract demand, but didn’t.
Take the yield on the benchmark 10-year German bund: it soared to as high as 0.897 percent Wednesday from as low as 0.049 percent on April 17. During the same period, the yield on similar maturity U.S. Treasuries surged to as high as 2.39 percent from 1.84 percent.
The benchmark Treasury 10-year yield was little changed Thursday at 2.37 percent as of 1:48 p.m. Tokyo. The price of the 2.125 percent note due May 2025 was 97 27/32.
At a conference in Cambridge, Mass., Michael Lorizio said he couldn’t keep his eyes away from his phone, where price alerts were announcing a crash in German bond prices. He said he skipped out early from the networking session, and headed back to his office in Boston.
“I couldn’t pay attention to any of the content, I was just watching the price action,” said Lorizio, senior bond trader at Manulife Asset Management. “You’ve had to be a little more decisive because prices are moving very quickly.”
At a news conference in Frankfurt Wednesday after an ECB policy meeting, where it didn’t even change rates, Draghi suggested several reasons for the rout in bonds. He cited including an improving economic and inflation outlook in the euro area, heavier issuance, volatility, poor market liquidity and an absence of certain investors.
Draghi, the architect of a 1 trillion-euro ($1.13 trillion) bond-buying program, is an unlikely foe of the bond market. Quantitative easing provides an almost endless source of demand for bonds and should keep yields low.
Instead, it’s made investors overly sensitive, said Jim Bianco, president of Bianco Research LLC in Chicago.
“You want to shove rates down to zero, people are going to make big bets because they don’t think it can last,” Bianco said. “Every move becomes a massive short squeeze or an epic collapse — which is what we seem to be in the middle of right now.”
This time, it was a June 2 report that the euro zone had experienced one month of inflation, of 0.3 percent, the first increase in six months, which sent investors overboard. That set off doubts about how long ECB policy makers will cling to a set of stimulus measures that look more appropriate for Europe in the throes of recession and deflation.
After five years of unprecedented central bank stimulus the reversal is a blow. Last year, global investors earned 7.8 percent on bonds, compared with 4.8 percent on stocks.
“We were very complacent, we were at very low yields for a long time,” Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, one of 22 primary dealers that trade with the Fed. “All you had to do was look all around the globe to see all the debt that’s accumulated over the last few years, and we’re finally maybe facing that, in that we’re seeing rates rise for no clearly apparent reason.”
Mike Schumacher, head of global rates strategy in New York at UBS AG, also a primary dealer, was telling investors to exit bunds at the start of the year. His prediction, that 10-year bunds would yield 0.9 percentage point, is within a basis point of coming true.
The bond rout has been exacerbated by dealers who have reduced trading activity amid regulations restricting their use of capital. Dealers cut their U.S. government debt holdings to $22.9 billion as of May 20, down from a record high $146 billion in October 2013, Fed data show.
“A lot of the risk takers are no longer there, the balance sheet’s not there and the liquidity’s going away,” Charles Comiskey, head of Treasury trading at Bank of Nova Scotia in New York, another primary dealer. “The usual suspects that come in to buy the market and support the market aren’t there. There’s selling going on and there’s nobody there to stop it.”