Investors stunned by blowout bond rally

A record-breaking global bond rally accelerated on Friday, with growing fears over the economic impact of coronavirus sending investors scrambling for the safety of government debt at the fastest pace since the financial crisis of 2008.

The gains pushed yields around the world to all-time lows after bond buyers doubled down on bets of further easing by central banks following the Federal Reserve’s emergency rate cut on Tuesday. The pace of the rally suggested an indiscriminate rush for haven assets.

“It’s pure fear — you can see it in the empty supermarket shelves and you can see it in the bond market,” said Dickie Hodges, a fund manager at Nomura Asset Management.

Mr Hodges has spent the week cashing in his bets on falling equity markets and using the proceeds to load up on 10-year and 30-year US government bonds. “We are in a global recession, but a lot of people just don’t realise it yet,” he said.

The 10-year US Treasury yield — a key reference point for markets around the world — fell 0.2 percentage points on Friday to a historic low of 0.7 per cent. It has dropped from above 1.5 per cent just two weeks ago. Yields fall when prices rise.

“It has been a whirlwind. A tumult,” said Nathan Sheets, chief economist at PGIM Fixed Income and former under-secretary for international affairs at the US Treasury. “Rates have been much lower than anybody expected, and they just continue to march lower.”

Germany’s 10-year bond yield — which serves as a benchmark for the eurozone — also traded at a record low of minus 0.74 per cent, eclipsing the record set during last summer’s epic bond rally. Investors expect the European Central Bank to follow the Fed’s lead by cutting interest rates next week. Ten-year borrowing costs in the UK also hit a new low of 0.24 per cent.

Still, the biggest gains have come in the US government bond market, where longer-dated Treasuries have racked up a return of more than 17 per cent this year. Even the US stock market has beaten that gain in only five calendar years in the past two decades.

“US Treasuries have yet again confirmed their role as the main insurance policy for markets,” said Andrea Iannelli, investment director at Fidelity International. “They have outperformed everything else out there in fixed income.”

Investors have snapped up Treasuries, betting that the Fed has more room to cut interest rates than other major central banks, and that the bonds have more scope to rally given that they still trade with a positive yield.

To some investors, that is too far too fast. “When we watch the 10-year [yield] fall the way it has done, like a lead balloon, that suggests a rising chance of recession,” said Kristina Hooper, chief global market strategist at Invesco. “But the 10-year doesn’t have a medical degree . . . It is hard to divine how growth will be impacted.”

The US central bank has already slashed interest rates by half a percentage point in an emergency move, and is expected to cut by another half-point at its regularly scheduled meeting this month. Meanwhile, swaths of the eurozone government debt market already trade with a negative yield, and the ECB is in the midst of an internal debate about whether more deeply negative rates might do more harm than good. The global stock of negative-yielding debt is more than $14tn.

“The ECB is what to keep an eye on,” said Iain Stealey, a bond fund manager at JPMorgan Asset Management. “The Fed has already shown its cards, but the market is telling the ECB that it has to get involved as well.”

Technical factors may be exacerbating the ferocity of the Treasury rally. JPMorgan’s strategists said that the sharpness of the gains had likely been accentuated by the retreat of high-frequency traders, which have become increasingly important to lubricating the exchange of US government debt in recent years.

Rampant demand for safety, coupled with a “sudden drop in market depth”, had produced a “mini flash rally” reminiscent of a wild ride Treasuries went on in October 2014, which led to a US government investigation into electronic trading of fixed income, JPMorgan said in a report.

Friday’s moves left investors casting around for historical parallels. Jim Leaviss, head of retail fixed interest at M&G Investments, said the huge gains for long-dated Treasuries reminded him of the response to the blow-up of hedge fund Long-Term Capital Management in 1998.

Many bond investors began the year positioned for a gradual drift higher in bond yields, betting that last August represented the high water mark for bond prices. Their capitulation as the virus continued to spread helps explain the ferocity of the moves, according to Mr Leaviss.

“The market has been caught off guard expecting the end to a 40-year bull market in bonds,” he said. “That was never justified by the fundamentals. Then you get something of this magnitude and it’s a massive shock to the system.”

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