Global sovereign bond rout deepens


The yield on the benchmark 10-year treasury note touched 2.301% earlier Monday, the highest intra-day level since December 30, according to Tradeweb. That was above the 2.273% at the end of 2015. Yields rise as bond prices fall.

The yield recently traded at 2.267%, still sharply higher from 2.118% on November 10. The bond market was closed Friday for a public holiday.

Bond yields in the developed world have been rising after hitting their historical low levels following the Brexit vote this summer. The 10-year yield closed at a record low of 1.366% in early July, delivering strong capital gains for bond buyers.

But the capital gains have been petering out with the rise in yields amid signs of improvement in global manufacturing and uptick in global inflation data, highlighting bond investors’ vulnerability to abrupt and large yield increases in a prolonged low-yield era.

The rise has been intensifying over the past week following Donald Trump’s victory from the US presidential election.

Trump has been advocating infrastructure spending, tax cuts and lighter banking regulation aiming to promote jobs and boost the US economy. He reiterated the priority to create jobs in a wide-ranging interview with CBS “60 Minutes” aired on the night of November 13.

The prospect of a fiscal boost to the economy is sapping demand for haven assets, driving investors to embrace stocks and commodities. Inflation expectation is rising, driving investors to sell regular treasuries and seek protection in treasury inflation-protected bonds. Inflation chips away the fixed returns on bonds over time and is a big threat to long-term government bonds.

Further spooking bond investors, large fiscal stimulus typically require a rise in government bond issuance for funding. At a time when demand for government bonds is diminishing, more debt supply would add to selling pressure and send bond yields higher.

“Trump’s election has been viewed as a game changer, with the potential for fiscal stimulus, pro-business reforms and protectionist measures all being priced in to markets,” said Mitul Patel, head of interest rates at Henderson Global Investors.

Tony Crescenzi, senior market strategist at Pimco, said that a “major implication of the election is a likely pivot away from central bank dominance to fiscal dominance. He believes that this shift “will lead to an upward bias for economic growth, inflation, and bond yields”.

Some analysts caution that the bond market may be getting ahead of itself.

The actual policy from Trump remains an unknown, along with policy efficacy. If Trump fails to deliver, sentiment toward higher growth and higher inflation is likely to pull back, sending bond yields lower, say some analysts.

“Until there is greater clarity on the issues, we are advising investors not to over react” to the rout in the bond market, said James DeMasi, chief fixed-income strategist at Stifel Nicolaus & Co.

The bond market has wrongfooted many bond bears in the past as its resilience rattled those calling for the end of the super cycle of low yields since 1981. The bond market was hit hard by the taper tantrum during the summer of 2013 when worries over reduced bond buying from the Federal Reserve spooked bond investors and sending the 10-year yield up by more than 1 percentage point. But after rising slightly above 3% at the end of 2014, the yield has been falling again.

Even so, analysts say the bond market may overshoot to higher yields in the near term as selling momentum may drive more investors to pile into the trade.

Rising inflation expectation is giving a big boost to investors selling Treasury debt. The 10-year break-even rate, the yield premium investors demand to own the 10-year treasury relative to the 10-year treasury inflation-protected security, rose to 1.93 percentage point on November 14, a two-year high.

At that level, it suggests investors are expecting the US inflation rate at 1.93% on average over the next 10 years. The breakeven rate fell below 1.4% shortly after the Brexit referendum. It is now moving to the Fed’s 2% inflation target. Fed chairwoman Janet Yellen signaled last month that she would tolerate inflation running a bit hotter than 2% in order to fulfil its inflation mandate.

Signs of rising inflation and the prospect of fiscal stimulus may bolster the case for the Fed to raise interest rates, say analysts. One risk, say analysts, for the bond market is that the Fed may quicken its pace of tightening in 2017, which would put more selling pressure on treasury bonds.

On November 14, the yield on the two-year Tteasury note, highly sensitive to the Fed’s policy outlook, earlier rose above 1% to the highest level since January. It was recently at 0.985, up from 0.906% on November 10.

Fed-funds futures, a popular derivative market for hedge funds and money managers to place bets on the US interest rate policy outlook, suggested a 86% probability of a rate increase by the Fed’s December meeting, according to data from CME Group. The odds were 81% last week.

Some bond bulls say the rise in bond yields won’t last for long.

Steven Major, global head of fixed-income research at HSBC, said the 10-year treasury yield would rise to 2.5% in the first quarter of 2017, but sticks to his forecast that the yield would sink to 1.35% at the end of 2017. That would be a new record low for the yield based on his projection.

The rise “may hurt economic growth,’ he said. “Our view recognises the cyclical pressure pushing yields upwards but also that longer-term structural drivers, such as the debt overhang, will weigh on growth and yields.

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