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Photo: iStockPhoto

Is this the start of the long-feared global bond sell-off?

If this is the start of the long feared global bond sell-off, it may get ugly

It’s been argued for long that bond yields in developed markets are too low—a consequence of years of easy liquidity provided by global central banks. A lot of this liquidity found its way into global bonds, which drove prices up and yields down. The theory was that this would change when the US Federal Reserve ended its quantitative easing (QE) programme. QE ended last year but investors continued to buy into bonds and yields remain low. Then came the European Central Bank’s version of QE and yields across Europe tumbled to record lows earlier this year.

The result—a wide spread consensus that bonds are overvalued and perhaps even in a bubble. A 14 April Bank of America-Merrill Lynch survey had noted that the proportion of investors who say that bond markets are overvalued is at a record high. A net 84% of those surveyed said that bonds are overvalued, up from 75% in March.

On Wednesday, US Fed chief Janet Yellen also cautioned that bond yields are “very low" and could see a “sharp jump" when the Fed raises rates, according to a Bloomberg report.

It’s against this backdrop that the recent sell-off in global bonds has to be seen, and the impact of which is being felt across asset classes and across geographies.

The upward movement in US yields began a couple of months ago but accelerated in mid-April. Since 20 April, the US 10-year treasury yield has gone from 1.88% to 2.24%—the highest in nearly two months. The rise in European yields has been steeper, with the German 10-year yield moving up by 50 basis points and the French 10-year yield moving up by 55 basis points. One basis point is one hundredth of a percentage point.

There’s a range of reasons behind the fall in bonds—from the expectation that the US Fed will start raising rates this year, to the now substantial rebound in oil prices, and also calls from influential fund managers to go short on government bonds in countries such as Germany.

The first of those reasons is by now well documented. The Fed is widely expected to start raising interest rates this year, although the timing remains uncertain. Some say June, others expect a September hike; a few even say that economic weakness will force the Fed to not hike rates this year.

Oil seems to be a more immediate worry. Brent crude prices are edging close to $70 a barrel, while NYMEX crude has moved above $60 per barrel. Brent prices, which hit a low of $46.59 a barrel on 13 January, have since gained more than 47%. That’s a fairly rapid rise in oil prices, and one that justifies a reaction in other markets like bonds. The fear is that a jump in oil prices could lead to a quicker rise in inflation levels in the West, which, in turn, could prompt the Fed to raise rates sooner.

There is a third factor at play, at least in the European bond markets, and that’s some bold calls being made by prominent fund managers. On 21 April, Bill Gross, formerly of PIMCO and now with Janus Capital, said on Twitter that German Bunds (the term used for German government bonds) are the “short of a lifetime". “Better than the pound in 1993," he added in that tweet, reminding investors of the time when George Soros made a killing by going short on the British pound. (To be precise, it was late 1992 when Soros built up huge short positions in the pound, which eventually was among the reasons that the Bank of England was forced to withdraw from the European Exchange Rate mechanism and devalue the pound.)

Back in the present, the big questions are how far will this bond sell-off go and how quick will it come? Those are the questions that are riling markets across the world.

For India, the rising global yields have come at a time when the equity markets were already under pressure from foreign investor selling. The higher yields are adding to the nervousness. In fact, Mint’s data journalism team pointed out on Thursday that Indian equity markets have shown a remarkable inverse correlation with US treasury yields over a period of time. A point well worth noting (http://mintne.ws/1IjH8CG).

In the Indian bond markets, yields have risen by about 25 basis points since end-April. The initial move up was driven by local factors but now global yields have started to reflect in domestic bond yields as well. On 6 May, foreign investors sold $413 million in the domestic bond markets—the most since 27 January, 2014. Further liquidation of emerging market bond holdings cannot be ruled out if global yields continue to rise. Some selling may also come as a result of a weaker currency, which is falling because of outflows from the equity markets. This, in turn, could prompt existing foreign bond investors to lock in gains. The rupee weakened past the 64 per dollar level on Thursday—a 20-month low.

The key takeaway: watch those global yields, no matter which market you are in. If this is the start of the long feared global bond sell-off, it may get ugly.

Ira Dugal is assistant managing editor, Mint.

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