As fears over the spread of coronavirus intensify, even the safest corner of financial markets has been swept up in the global sell-off.
Government bonds, typically seen by investors as havens from volatility elsewhere, saw their prices tumble on Wednesday at the same time as fund managers continued to dumped riskier assets like stocks.
What is going on in bond markets?
In times of crisis, investors tend to pile into government bonds for their apparent safety. Markets followed this playbook at the start of the coronavirus outbreak, with bond yields around the world hitting record lows as prices soared.
That pattern has changed in recent days. The selling in bond markets accelerated early on Wednesday, pushing 10-year US Treasury yields above 1.2 per cent, the highest in more than two weeks and far above the record low of less than 0.4 per cent hit on March 9.
Europe’s benchmark, the 10-year yield on German government debt, touched a two-month high of minus 0.23 per cent, while 10-year UK yields surged to 0.79 per cent by late afternoon in London.
Why are investors selling?
They need cash. As the rout in equities and corporate debt continues, clients have been withdrawing money from mutual funds. To meet these redemptions, investors are being forced to dump the assets that are easiest to sell, traders say.
As some of the world’s most heavily traded assets, government bonds are an obvious candidate. “A lot of people are just trying to sell whatever they can,” said Seema Shah, chief strategist at Principal Global Investors.
Can central banks stop the rot?
They have certainly been trying. The US Federal Reserve cut interest rates to near-zero and announced $700bn of bond purchases on Sunday, and in recent days has ramped up its interventions in short-term funding markets.
The central bank has also announced the revival of a series of crisis-era programmes to shore up liquidity across financial markets. It has agreed to step into the commercial paper market, which companies use to raise cash, and is allowing approved dealers in government debt to borrow cash against some stocks, municipal debt and higher-rated corporate bonds.
The European Central Bank announced an extra €750bn of asset purchases at an emergency meeting on Wednesday after its previous interventions failed to arrest the slide in bond prices. The ECB’s move pushed German yields down from their recent high. Even so, despite the scale of central bank moves, bond yields around the world remain far above the troughs they reached in the early part of the coronavirus outbreak.
The main reason bonds usually rally in troubled times is that investors anticipate rate cuts — which increase the value of already-issued bonds — and other easing measures from central bankers. A large “bazooka” from the Fed and ECB was already priced in by the second week of March, leaving little room for a big rally.
What about fiscal policy?
Governments around the world are opening up their cheque books to cushion the economic blow from the virus. The White House has pledged $1tn in emergency stimulus, while the UK government revealed a £350bn package for UK firms. All that spending will require a big expansion in borrowing, meaning a greater supply of bonds. In theory, that should push down prices.
“We finally have the right talk about a fiscal response,” said Peter Tchir, head of macro strategy at Academy Securities. “Given how low yields were on Treasuries, when we get a bit of positive news, there will be big selling”.
Even so, the outlook for the volume of bond issuance is not typically the main driver of yields, which usually reflect investors’ expectations of growth and inflation. Here, there is little sign of any optimism.
“If you are selling Treasuries when the Fed funds rate is zero and inflation expectations are low, you are selling [them] not because you want to, you’re selling [them] because you need to,” said Jim Caron, a senior portfolio manager at Morgan Stanley Investment Management.
What does the sell-off mean for funds?
As sentiment sours, fixed income funds — particularly those investing in corporate or riskier debt — are under pressure across the board from heavy redemptions. Many such funds may also hold some government bonds, which they are finding easier to sell to pay back departing investors.
Last week, one popular arbitrage strategy in the Treasury market came under intense pressure, with traders saying some funds were forced to sell government bonds to protect against further losses. This rapid selling compounds selling activity elsewhere, driving yields higher.
Is there anywhere safe left for investors?
The bond sell-off appears to have removed the last haven available to nervous investors, who are instead sheltering in cash. Gold, another asset which usually rises amid market turmoil, has plummeted over the past two weeks.
“There’s nowhere to hide now,” said Ms Shah. “What you are seeing in sovereign bonds speaks to the level of malfunctioning in markets. The market is now fearful that things will go on like this, until you see infection rates peaking.”
Additional reporting by Joe Rennison