Bond markets have been rocked by signals from central banks that interest rate hikes are approaching, causing the biggest price drops since global debt fell earlier this year.
Investors ditched government bonds following the latest policy meetings of the U.S. Federal Reserve and the Bank of England last week, in which the two indicated their willingness to respond to mounting inflationary pressures by raising prices. short-term borrowing costs.
At the same time, a surge in energy prices in Europe – and particularly in the UK – has reinforced the belief of fund managers that the rise in inflation will last longer than bankers had predicted. central.
“Central banks have tried to convince us that inflation is transitory,” said Dickie Hodges, bond fund manager at Nomura Asset Management who bet against US Treasuries. “Given the circumstances, I think they’ve been in denial – if you can show me something that’s cheaper today than it was before the pandemic, I’d be surprised. So I think a reassessment is overdue.
Last Wednesday, the bond market barely reacted to news that a growing number of Fed officials are expecting a rate hike next year, with the US central bank saying it could “easily go out of the way.” ‘avant’ with its intention to reduce its bond purchases as early as November.
But a more pronounced hawkish turn by the BoE the next day – with the UK central bank signaling that a hike could come before the end of the year – sparked a wave of selling that quickly spilled over into global markets and continued this week, pushing yields sharply. upper.
“The sustained upward movements in Treasury yields tend to be more globally oriented. We don’t see it as a coincidence that the hawkish Bank of England meeting coincided with this rate hike, ”said Kelsey Berro, bond portfolio manager at JPMorgan Asset Management.
On Tuesday, the 10-year US Treasury yield, a benchmark for financial assets around the world, climbed to 1.55%, the highest level since June and up sharply from 1.31% a week earlier .
Movements in the UK were more pronounced, with 10-year gilt yields exceeding 1% for the first time since March last year, more than doubling levels seen at the end of August. Even the euro zone, where rising interest rates are a more distant prospect, has not been spared. The 10-year German Bund yield rose on Tuesday to a three-month high of minus 0.17%.
The accompanying decline in bond prices means the Barclays Global Aggregate Bond Index – a broad indicator of corporate and government debt around the world – is down around 1.6% in September, its biggest drop since March.
Trend-following “commodities advisers” hedge funds sold about $ 81 billion in treasury securities over the past week as they took bets against the market, according to Citi analysts. Citi analysts. After months of net long positions in global interest rates, the positioning is now short.
Investors and analysts have said that the BoE in particular has paved the way for a revival of this so-called “reflation trade”.
“We’ve been through most of this year thinking the BoE would raise rates sooner than the markets thought, and before the Fed,” said Sandra Holdsworth, UK head of rates at Aegon Asset Management. . Still, the BoE’s assertion last week that rates could rise before its bond buying program expires at the end of the year was a “big surprise,” he said. she declared.
In a speech on Monday night, BoE Governor Andrew Bailey made no attempt to push back market expectations of a rate hike by February, sparking a new wave of sales. An increase to 0.25% by December is seen as a draw by the futures markets.
Unless a new wave of the virus results in further closures or the end of the government’s leave program disrupts growth, even an increase in November is possible, Holdsworth believes.
In Europe, debt clearance is partly explained by higher long-term inflation expectations, which erode the fixed interest payments offered by bonds.
A closely watched indicator of expectations for retail price inflation over the second half of the next decade has climbed to 3.85 percent in the UK, the highest in 12 years. The equivalent measure for euro area consumer prices is at a six-year high of 1.81 percent.
The Fed’s expectations for US inflation have also risen. In the statement following last week’s meeting, Fed officials saw core inflation at 3.7% in 2021, up from its estimate of 3% in June. Next year, the Fed is forecasting inflation at 2.3%, against a previous estimate of 2.1%. President Jay Powell, in a speech to Congress on Tuesday, said inflation could stay higher for longer, especially if supply chain problems persist.
Inflation expectations in Europe, the UK and the US could continue to rise with energy prices. Brent crude, the world’s benchmark for oil, surpassed $ 80 a barrel on Tuesday for the first time in more than three years. Other commodities, including coal, carbon and European gas prices, have all hit record highs.
“The dominant driver of long-term global bond yields appears to be simply the growing energy crisis,” said Mike Riddell, portfolio manager at Allianz Global Investors.
“This does not immediately make sense because the energy crisis is likely to be a supply shock in the short to medium term and should not lead to a structural rise in central bank interest rates. But soaring gas prices create longer-term inflationary uncertainty, where this additional risk premium is built into [bond yields]. “