Bond Market Meltdown: 5 Reasons That Explain Why
More than $450 billion has been wiped out across global bond
markets in the past few weeks and, for many people, there doesn't
seem to be any particular reason why. Sovereign-bonds yields had
fallen so far that in order for them to make sense, investors would
have needed to see persistent deflation and European recessions.
For a while, that seemed like a real possibility, as oil went from more
than $100 a barrel to less than $50 and many forecasters were
predicting $30. Well, that didn't happen, and oil started to rise at the
same time as evidence of incipient inflation and economic growth in
Europe.
Introduction
That sparked speculation -- proven to be unfounded -- that the
European Central Bank could even end its bond-buying program
early. Against that backdrop, holding bonds with yields close to zero
made little sense, causing investors to unwind one of the most
crowded trades in all of markets. Here are a few reasons that explain
why.
Introduction (Contd.)
#1
Oil
Bonds became a favorite place to profit from the market turmoil
sparked by crude oil's rapid collapse last year as investor bet it meant
an end to the risk of inflation. Now that the price for crude seems to
have stabilized, and even rebounded, the threat from the main
nemesis of fixed-income investors is renewed.
Oil
Brent Crude Price
#2
Inflation
The rebound in oil may be sowing the seeds of a very good reason
not to own bonds: inflation. Because most bonds' coupon payments
are fixed, rising inflation lessens the value of each one of those
payments in the future. That didn't matter when it looked like falling oil
prices could drag Europe and other parts of the world into deflation,
prompting central banks to cut rates and the ECB to launch its bond-
buying program. Now, all that central bank action, along with the
bounce in oil, may actually be working. Inflation in the euro zone
stopped falling last month after going negative at the end of last year.
Inflation
Euro Area Inflation
#3 European
Growth
The early signs of inflation and positive economic growth coming out
of Europe is causing increased optimism the currency bloc may
actually pull out of its funk. After spending the end of last year
slashing 2015 growth forecasts for the euro zone, economists are
raising estimates again. As recently as February economists were
calling for the euro zone to grow 1.1 percent this year. Now they've
raised their median forecast to 1.4 percent, according to a Bloomberg
survey.
European Growth
Euro Area Growth Forecasts
#4 Positioning
Too many people were invested too heavily in bonds. Data from the
Commodity Futures Trading Commission show investors started 2015
with the biggest bet on U.S. government bonds in seven years. By the
end of the first quarter, more than half that position was gone.
Positioning
U.S. Treasury bond futures long
positions
#5 Sub-Zero
Yields
Between the ECB's bond buying and the threat of deflation, yields
across Europe started to go negative this year, meaning investors
were essentially paying for the privilege to lend their money out. That
created a spillover effect into bond markets in the rest of the world as
investors went in search of a better deal, pulling yields down in those
markets too. The average yield across all Germany's debt went
negative about three weeks ago. That seems to have been the straw
that broke the camel's back. Since then that average yield has
climbed to the highest level this year. Yields on about $2 trillion of
bonds across 12 countries still linger below zero.
Sub-Zero Yields
Bloomberg German Sovereign Bond
Index yields
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