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Home / Mutual Funds / News /  Investors fear bond-market turmoil is entering a new phase

Investors fear bond-market turmoil is entering a new phase

On Wednesday, the Bank of England stepped in to stop a rout in the U.K. gilts market, spurring a rally on both sides of the Atlantic.

Even in a year of outsize bond moves, the past week has stood out

Mounting volatility in government bond markets is intensifying fears on Wall Street that this year’s wild swings in the world’s safest assets could further destabilize already rocky financial markets.

Mounting volatility in government bond markets is intensifying fears on Wall Street that this year’s wild swings in the world’s safest assets could further destabilize already rocky financial markets.

The worst bond rout in a generation carried the yield on the 10-year U.S. Treasury note above 4% for the first time in more than a decade on Wednesday, before emergency moves by the Bank of England prompted the biggest one-day rally in more than 13 years. The yield, a benchmark for borrowing costs on everything from mortgages to corporate loans, fell a quarter of a percentage point in a day.

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The worst bond rout in a generation carried the yield on the 10-year U.S. Treasury note above 4% for the first time in more than a decade on Wednesday, before emergency moves by the Bank of England prompted the biggest one-day rally in more than 13 years. The yield, a benchmark for borrowing costs on everything from mortgages to corporate loans, fell a quarter of a percentage point in a day.

The historic reversal marked the latest explosion of volatility in normally placid debt markets, raising investor worries that the yearlong selloff in bonds has entered a new and more dangerous phase. Once an orderly—if rapid—decline driven by the Federal Reserve’s rate increases and the trajectory of inflation, the latest swings have been spurred by events outside the country, particularly efforts by global central banks to fight inflation and a rapidly strengthening dollar.

Surging yields, which rise when bond prices fall, are buffeting markets. Through this point of the year, major bond indexes have never suffered bigger losses. Stocks have sunk, particularly shares of more speculative companies. The S&P 500 has lost 22% this year.

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Investors may or may not think Treasury yields appropriately reflect the outlook for U.S. interest rates. But now, “the wild card is really what’s happening everywhere else," said Leah Traub, a portfolio manager at Lord Abbett.

Even in a year of outsize bond moves, the past week has stood out. The relative calm that greeted the Fed’s three-quarters of a percentage point rate increase last week rapidly gave way to days of intense selling. Yields shot upward a week ago after a handful of global central banks aggressively raised their own benchmark interest rates and Japan’s government moved to support its currency by selling dollars and buying yen.

Yields got another jolt when the U.K. government announced an unexpectedly large package of tax cuts, to be funded by new borrowing. That set off extreme selling in U.K. bonds that spread across borders.

Then on Wednesday came the surprise intervention by the BOE, which sought to calm the U.K. market by saying it would delay bond sales and start purchasing longer-term U.K. gilts. That triggered a frantic bond rally on both sides of the Atlantic.

By the end of Wednesday, the yield on the benchmark 10-year U.S. was around 3.7%—down from its intraday peak of nearly 4.02% but still up from about 3.5% in the hours just after the Fed meeting.

Such giant swings in yields are often fueled by idiosyncratic factors, as well as economic fundamentals, investors and analysts noted.

Institutions forced to sell assets or hedge other bets often sell the most easily traded assets available—U.S. Treasurys—exacerbating price declines. In the other direction, bond rallies can be supercharged when institutional investors are forced into buying when their bets on falling bond prices require them to purchase bonds to close out their positions.

Few expect the underlying causes of the recent volatility to dissipate soon.

Interest rates are still much higher in the U.S. than in much of the developed world, such as Europe and Japan. That, along with anxieties about a global recession, are weakening a broad range of currencies relative to the U.S. dollar.

That in turn is feeding inflation in those economies, putting extra pressure on their governments and central banks to raise interest rates or otherwise take action to strengthen their currencies.

“At the core of it, those central banks have to do what the Fed is doing and maybe perhaps a little bit more because their currencies are weakening," said Thanos Bardas, global co-head of investment grade at Neuberger Berman.

That is why, he added, “I think this volatility in the global rates market is just not going to go away until the Fed basically stops hiking."

Some also noted the BOE’s intervention this week amounted to only a stopgap fix for the problems that have unnerved investors.

The central bank has made it clear that it intends to bring down inflation, which is already higher in the U.K. than many other developed countries and could be further fueled by the government’s new tax cut plans.

“Asset purchases will likely prevent yields from continuing to spike in an exaggerated fashion, but they won’t prevent yields from remaining high or even go higher in the future," Roberto Perli and Benson Durham of Piper Sandler wrote in a note to clients Wednesday.

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