Thursday 7th May 2015
Oil price up, bond yields soar (and therefore prices crash) ...... what's changed ?
"Oil price jump quickens sell-off in international debt
markets" , The Financial Times, p.1 , see also Editorial comment p.12,
Market reports p.31.
Was it all just a dream ? They're all inter-related of course, but
let's take one step at a time.... Benchmark Brent crude has rallied from a low
in January of $45 per barrel to nearly $70 at its high yesterday, a rise of
over 50%. The reasons ? Reduced production in war-torn Libya,
concern that the situation in Yemen might disrupt supplies from the Middle
East, a reversal of fortune for the previously rampant US$ (in which oil prices
are quoted), signs of life in the European economy that might boost demand, and
because it was oversold. Adding fuel to the fire yesterday was news that weekly
inventories (stocks) in the US fell for the first time in four months.
Higher oil prices raise the prospect of inflation, and by
extension higher rates. Despite the benefits of cheap oil, even central banks
in oil-importing nations will be grateful that the threat of deflation seems to
be easing and those signs of recovery in Europe would seem to confirm the
impression. But higher rates and yields mean lower bond prices
-- prices and yields move inversely, of course. We've seen a spike in
bond yields across the globe, but to take one example : the yield on the 10yr
German Bund has rocketed from below 10 basis points in mid-April to above 50
basis points .... a staggering move for sure but as the FT leader points out,
perhaps the question we should be asking is not "Why are 10yr bunds
suddenly yielding 50bp?" but rather "What were those people doing
buying bonds yielding 10bp in the first place?".
In part, the answer to that lies with the false sense of security
given to the unwary by the ECB's Quantitative Easing programme. Even at 10bp,
buyers felt that if needs be they could always pass on their paper to the ECB
at an even lower yield (and higher price). Ah, but the market's turned and
those buyers are facing big losses on positions that they're scrambling to
get out of. To make matters worse the lack of genuine liquidity in bond markets,
a recurring theme in this blog, has no doubt played its part in
making the reverses even sharper. Many understood the rationale behind buying
bonds with such low or even negative yields but questioned its wisdom, to which
the buyers might point out that in the search for somewhere safe to put their
money their options are severely limited. Perhaps, but it's not looking such a
safe strategy now and all should remember that there's no such thing as a free
lunch.
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