A fierce sell-off in the US bond market abated late on Wednesday but left yields on benchmark government debt at their highest level in nine months, with some high-profile debt investors declaring a new era for fixed income investments.
The yield for 10-year Treasuries on Wednesday approached levels not seen since the “Trumpflation” retreat nearly a year ago, hitting a nine-month intraday high of nearly 2.6 per cent as investors fretted that central banks were poised to move more aggressively than anticipated to end their crisis-era economic stimulus programmes.
The weakness has also been stoked by expectations that cash freed up by the recent US tax cut will finally help spark higher inflation driven by stronger economic growth.
An eagerly anticipated auction of 10-year US Treasuries later produced the highest ratio of demand since 2016, underscoring how higher yields can entice investors back into the market. That helped trim the yield rise and by early afternoon the yield was less than 1 basis point higher at 2.56 per cent.
The global government bond market has started 2018 on the back foot, and yields rose sharply on Tuesday after data showed the Bank of Japan had slowed some of its long-dated bond purchases. That stoked speculation that the Bank of Japan would join the European Central Bank and US Federal Reserve in scaling back stimulus programmes this year.
The sell-off deepened early on Wednesday on market speculation that Chinese authorities viewed US government bonds as less attractive. The sense that the three-decade bond bull market was coming to a close was reinforced by Bill Gross, the so-called bond king, who publicly declared his funds were short selling US Treasuries.
Jeffrey Gundlach, the founder of DoubleLine Capital who is viewed as Mr Gross’s rival and is a closely followed bond investor, lent his weight to the bearish sentiment, saying central bank policy was shifting to an “era of quantitative tightening”.
While the Japanese central bank’s trimming of long-dated bond purchases was not announced as an official change of policy, it was enough to reinforce the sense 2018 will mark a turning point in the post-crisis era of ultra-stimulative monetary policy.
The yield on 10-year German Bunds has climbed to a six-month high of 0.54 per cent; January marks the start of the ECB’s halving of its bond purchases to €30bn every month. Even the Japanese 10-year government bond yield — which is still subject to the central bank’s “yield curve control” that aims to keep it at zero — has risen to 0.08 per cent this week, the highest since July.
As a result of the sell-off, the biggest fixed-income exchange traded fund, the $53bn iShares fund trading under the symbol AGG, has lost 0.3 per cent this week to trade at an eight-month low on Wednesday.
Even before the Donald Trump-backed tax cuts, expected to stimulate the economy, the world’s most important central banks had been slowly bringing an end to the emergency stimulus measures as the economic recovery in Europe and the US gained steam.
Economists have remained bemused by the lack of price and wage increases despite the tightening job market on both sides of the Atlantic, but many now believe the US tax cuts will provide the boost needed to trigger inflation — which could force central banks to tighten monetary policy even more aggressively.
The 10-year US “break-even” rate — a measure of inflation expectations derived by comparing the yields of inflation-proofed and conventional Treasury bonds — has this month climbed above the 2 per cent mark for the first time since March last year.
Not all investors are convinced that inflation is finally on the rise. Oliver Jones of Capital Economics noted that factors such as a global savings glut and new technologies that allow companies to keep prices low would keep inflation in check.
“We think that investors are underestimating how quickly the Fed will raise interest rates this year. But we doubt that this would mark the start of a bloodbath in bond markets, even allowing for reduced support from central bankers and reserve managers outside the US,” Mr Jones said.
Mr Gross, who earned the “bond king” nickname while chief investment officer at Pimco and is now a fund manager at Janus Henderson, wrote on Twitter: “Bond bear market confirmed today. 25-year long-term trend lines broken in 5yr and 10yr maturity Treasuries.”
Mr Gundlach warned that it would be a “big deal” if yields on the 10-year Treasury broke through 2.63 per cent — something that would breach a technical level and accelerate the sell-off, he predicted.
The US government bond market has repeatedly defied prophesies of a rout, and the 10-year yield has yet to breach 2.63 per cent, the high from last year that was reached on hopes that Mr Trump would turbocharge the US economy.
The bond market has enjoyed a remarkable three-decade bull run since central banks led by Paul Volcker’s Fed conquered inflation in the 1980s. The swingeing interest rate cuts and quantitative easing programmes that followed the financial crisis then helped supercharge the bull market, pushing the yield on trillions of dollars worth of bonds into unprecedented negative territory in recent years.
Yet there are rising concerns that with central banks tiptoeing towards tighter monetary policy, the long bond rally could stall — and perhaps even unravel — in 2018.
Fed policymakers are projecting three interest rate rises this year and the central bank has started to reduce the size of its crisis-bloated balance sheet, while the ECB is expected to end its own QE programme later this year.
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