Fixed Income: What's next as Long Duration Soverign Yields Hit Highs as Bond Investors flee.
Summary:
• Investor confidence in developed market sovereign bonds is wavering, as long-term yields spike.
• Recent pullbacks in yields may mark either the early stages of a bond market recovery or merely a pause in the selloff.
• Despite market fears, we maintain that the bond selloff is more cyclical than structural. For long-term investors, this could represent an opportunity to lock in higher yields with upside potential for price appreciation.
The Selloff Long-term Soverigns:
The last weeks have seen a downgrade in the US Soverign dent ratings, a historic spike in 30 year JGB's to 3%, a near 5% yield in US 30yr bonds (currently at 4.97%), and German and UK 10yrs having seen wild swings are down marginally on the week.
The US 30yr is at the second highest levels since 2008. And bonds of similar duration for Germany and the United Kingdom have seen similar upward moves in yields. As the Bloomberg chart below indicates.
(30 Year Japan, UK, Germany and US Boond Yields)
With US budget deficits at a record $1.15 trillion, and European governments heavily exposed to a US withdrawal from the Ukraine conflict, which might leave Europe funding the bill, investors are wary of a bond market rout, hence the selloff.
Our view is that, nothing has changed much in the way of the debt situation, these problems did not begin today. And so this selloff is basically a market repositioning in hopes of progress from trade deals to see uncertainties.
(Japanese Equities Year-to-date)
Equties have also been on a rebound in the past month from the March declines, in the countries above. The chart above shows Japan's Nikkei sideways in a y-o-y basis and upward trending m-o-m.
(Dow Jones industrial Average Year-to-date)
Germany's DAX and UK's FTSE 100 have also joined the party rebounding from March dip.
(Germany's DAX Year-to-date)
The bond market selloff coinciding with a stock market rebound represents a renewed positive sentiment in the markets or just a reaction to the huge deficit situation in the US economy is yet to ascertained.
But the yields seem attractive as a hedge against recessionary fears which we still very much hold as a possibility. The week-on-week performance could be the begining of a recovery or the end of the bond market selloff.
Begining or the End?
10 yr Yields in European (German, UK), and Japanese bonds are down w-o-w, suggesting a slowdown in the selloff of the past month as the m-o-m data shows in the charts above.
Whether a bond selloff is coming to an end to mark a repositioning towards (developed markets) bonds is left to be seen.
(JGB Yields m-o-m)
The Japanese 10yr bond yield is up +10.79% on a m-o-m basis. But down -2.83% w-o-w.
UK 10yr is up +1.35% m-o-m, but down -0.65% w-o-w.
An German 10yr bunds down 0.99% on the week, and +3.69% on the month.
Zero Equilibrium Bond Market Remarks and Expectations:
The bond market is
communicating to the governments on the need for more fiscal responsibility,
but that is not to say that Soverigns have lost their safe haven appeal.
We believe trading has more to do with the yield rise than investor selloff. If
recessionary fears continue, fixed income becomes attractive again and can act
as a hedge form portfolios exposed to Oil prices, which would be pressured
downwards in an economic downturn.
Central banks, —especially the US Fed— in that eventuality would most likely
respond with monetary easing or a partial reversal in monetary tightening.
We believe these bondmarket fears are overblown, and this presents opportunity
for bond investors, and long-term traders, for both yields, price appreciation
and risk management.
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