Government bond markets have suffered their worst two-month period in two years as investors struggled to divine the timing and extent of future interest rate moves.
Preliminary data from Lehman Brothers indicates March and April produced the worst absolute returns since April and May 2004 when the markets were readying for the US Federal Reserve to begin raising rates.
Following a 0.9 per cent drop in March, global bond markets are on course for a loss of about 0.7 per cent this month. This fed into wider gloom.
Lehman’s US Aggregate Bond Index is off 1.2 per cent to date this year, while the Pan-Europe index is down 2.7 per cent and Asia-Pacific indices have lost 1.3 per cent. A total of two thirds of all local government bond markets are posting negative absolute returns so far this year.
This week, Treasuries led world markets. Benchmark 10-year yields posted a series of new four-year highs as a series of extremely strong data fuelled market speculation that in addition to an already expected quarter-point rate rise in May, the Fed could continue with another rise to 5.25 per cent at its June meeting.
But that turned around on Thursday, when Fed chairman Ben Bernanke wrong-footed the market and hinted at an impending pause in rate rises by the central bank’s Federal Open Market Committee.
“Even if in the committee’s judgement the risks to its objectives are not entirely balanced at some point in the future, the committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook,” he told a congressional committee.
Whether a pause means just that or, in fact, an end was hotly debated in the market. Those expecting an end – and betting on a resulting steepening of the yield curve – won the day.
Traders positioning for steepeners are betting that rate-sensitive, short-dated yields will fall faster than longer-dated ones because they believe it will become clearer that the next move in rates will be down.
On Friday, the 10-year yielded 5.097 per cent, up from 5.025 per cent as the week began, but off a peak of 5.145 per cent.
In Germany, Bund yields pushed above 4 per cent for the first time in 18 months, helped by a combination of hawkish comments from central bankers and strong data.
New numbers on Friday added to the general mood, showing an unexpectedly sharp jump in inflation, while separate money supply data also stoked rate rise expectations. The European Central Bank meets next week, and investors are jittery. “Trichet [Jean-Claude, ECB president] must be regretting the day that he put the markets off the scent of a May rate hike and onto the trail of a rate tightening in June,” said David Brown at Bear Stearns.
“With eurozone inflation pushing back up and eurozone economic confidence surging, the ECB should, in theory, have all the ammunition they would need for a rate hike in May.”
The Bund on Friday yielded 3.966 per cent, up from 3.938 per cent on Monday but off a high of 4.033 per cent on Thursday.
UK markets tracked the eurozone, and the 10-year gilt yield hit a year-high at 4.72 per cent on Thursday, but was back at 4.645 per cent on Friday.
Japanese government bond investors initially tried to resist the rise in yields elsewhere as they waited for the Bank of Japan’s semi-annual economic outlook on Friday to gauge the timing of the first interest rate rises in years.
But the market gave in to the selling mood ahead of the report, helping 10-year yields touch 2 per cent from 1.885 per cent on Monday.
The yield was back at 1.930 per cent yesterday as rate rise fears were damped by soft inflation data and a lack of new hawkish surprises in the BoJ’s statement on the economic outlook.