Another poor week for bonds...

Friday 28th October 2016

  

Another poor week for bonds ..... is it really the end of the big "Buy" story? And the thing about "Duration"......

ref:- "Gilts lead sell-off of sovereign debt", The Financial Times, Markets and Investing

ref:- "Austria 70-Year Bond Hands Out Duration Lesson in First Week", Bloomberg Markets

"Bond yields up, prices down" is becoming an uncomfortably familiar refrain of late, so you've got to ask yourself whether recent action might signify a fundamental change. For so long it seemed that purchasing government debt was just the easiest way to make money even if the interest returns were negligible (or even negative)  --  it doesn't seem so easy any more, though. It's much too early to make the call that the bond market boom is over, and the jumpy nature of the markets means that they are probably equally susceptible to an unexpected piece of good data as they are to bad. Nevertheless, this week will have done nothing to calm the nerves.

Some numbers regarding yields on 10yr sovereign bonds : US Treasuries are trading at 1.85%, having made a low earlier this week at 1.75%. For German Bunds, read 0.17% and 0.02% respectively. UK Gilts, 1.26% against 1.08%. Japanese Government Bonds (JGBs), -0.04 after -0.06.

Generally speaking, spill-over sentiment and the very close correlation between government debt markets means that a move in one area will be replicated to at least some degree in others ..... apart perhaps from Japan. You can see the muted response in JGBs, and we can put that down to the Bank of Japan's new(ish) policy of exerting a strict control over the yield curve and keeping 10yr yields at or around 0%. But for the others, this has been a week when each has also had its own reasons to push yields higher and prices lower.

The UK, not for the first time recently, has been leading the way but not because of the inflationary effects of a tumbling currency. A 3rd Quarter GNP number of +0.5% (against expectations of +0.3%) was 0.2% lower than Q2's very strong figure but still represents a surprising resilience in the UK economy. Along with the Pound's problems it has led some commentators to suggest that the next move in interest rates may in fact be a rise, when most had assumed that the economy's post-Brexit problems would prompt a cut.

The US markets having been getting to grips with the increasing chances of a rate hike in December. Futures prices suggest that the probability of such an event is now 73%. (It is just possible that they could go next week at their November meeting, but there is no press conference scheduled and a policy move is very unlikely). As you can read elsewhere on Bloomberg markets today, there is a growing trend to move at least some money away from bond markets and into cash, or short-dated instruments like T.Bills.

Germany and Europe as a whole has also shown some stronger measures of economic activity, with PMI (Purchasing Managers Index) readings for the Eurozone and Germany's IFO data (Business Confidence) both above expectations. All the talk is about how long the ECB can (or would want to) maintain it's highly accommodative monetary policy.

*** STOP PRESS *** US 3rd Quarter Preliminary GDP data has just been released showing annualised growth of 2.9% . Estimates were centred around the 2.5/2.6 mark, and the number is unlikely to offer any support.

For those not intimately involved in bond markets, these might seem inconsequential moves ..... far from it. Remember we were talking about Duration the other day? "Duration is a measure of the sensitivity of the price to a change in interest rates ...." and all that? We may also have mentioned Austria's new issue of a 70-year bond with a coupon of just 1.5%, which was snapped up greedily by investors. Well, its extremely long maturity and low coupon give it a very high measure of duration, which means that its price is highly volatile and sensitive to rate changes.

By way of comparison, the duration of Bank of America's Global Government Bond Index hit an all-time high in July of about 8.5  --  the duration on Austria's new ultra-long bonds is 43 (yes, 43). The yield on these fellas has gone out to about 1.68%. So to put that in cash terms: Austria issued 2 billion euros of the new bonds. If you were a not particularly large fund manager who secured himself 10 million euros of the new issue, at the end of the first week you'd be sitting on a loss of over 500,000 euros. Don't know about you, but not all of us would consider that "inconsequential"....