Sat. Oct 16th, 2021

Bond markets have been ripped out of their late summer slumber by the central bank’s signs that interest rate hikes are approaching, which has resulted in the sharpest price declines since a global debt shift at the beginning of the year.

Investors dumped government bonds in the wake of the latest policy meetings last week at the US Federal Reserve and the Bank of England, both of which indicated they were prepared to respond to rising inflationary pressures by raising borrowing costs in the short term.

At the same time, a rise in energy prices in Europe – and especially the United Kingdom – has contributed to convincing fund managers that the jump in inflation will last longer than central bankers previously expected.

“Central banks have tried to convince us that inflation is transient,” said Dickie Hodges, a mortgage fund manager at Nomura Asset Management who is betting on the US Treasury. ‘Given the circumstances, I think they were denied – if you could show me one thing that is cheaper today than before the pandemic, I would be surprised. So I think a reassessment was too late. “

The bond market initially reacted barely to news last Wednesday that a growing number of Fed officials expect interest rates to rise next year, as the US Federal Reserve said it could “easily proceed” with plans to close its mortgage purchase as soon as November end.

But a more pronounced hawkish shift from the BoE the next day – with the British central bank indicating that a rise could come before the end of the year – caused a wave of sales that spread rapidly through world markets and continued this week, pushing yields sharply higher.

Line graph of 10-year government yields (%) showing bond yields jumped higher

‘Sustainable increases in treasury yields are typically more global. “We do not consider it a coincidence that the Hawkish Bank of England meeting coincided with this rise in interest rates,” said Kelsey Berro, manager of fixed income portfolio at JPMorgan Asset Management.

The U.S. Treasury’s 10-year yield, a measure of financial assets around the world, rose Tuesday to 1.55 percent, the highest level since June and a sharp rise of 1.31 percent a week earlier.

Movements in the UK were sharper, with a 10-year return for the first time since March last year, more than 1%, more than doubling the levels recoded at the end of August. Even the eurozone, where higher interest rates are a distant prospect, has not been spared. The 10-year German Bund yield rose to a three-month high of minus 0.17 percent on Tuesday.

The concomitant fall in bond prices means that the Barclays Global Aggregate bond index – a broad level of corporate and government debt worldwide – fell by about 1.6 percent in September, the biggest drop since March.

According to Citi analysts, today’s “commodity trading advisor” hedge funds sold about $ 81 billion in treasury shares while betting on the market. After months of net long positions in interest rates worldwide, the positioning is now short.

Investors and analysts said the BoE in particular had paved the way for the revival of this so-called “reflection trade”.

“For most of this year, we thought the BoE would raise rates sooner than the markets thought, and ahead of the Fed,” said Sandra Holdsworth, head of the UK at Aegon Asset Management. Still, the BoE’s claim last week that interest rates could rise before its mortgage buying program runs out at the end of the year was a “big surprise,” she said.

BoE Governor Andrew Bailey in a speech on Monday night made no attempt to return against the market expectations of an interest rate hike by February, which caused a new wave of sales. An increase to 0.25 percent by December is seen by futures markets as a currency.

Unless a further wave of the virus leads to renewal, or the end of the government’s course of the scheme could interrupt growth, even an increase in November is possible, Holdsworth believes.

In Europe, debt sales are driven in part by an increase in long-term inflation expectations, which erodes the fixed interest payments offered by bonds.

In the second half of the next decade, an accurate measurement of retail price inflation expectations in the UK rose to 3.85 per cent, the highest in 12 years. The equivalent measure of consumer prices in the eurozone is at a peak of six years of 1.81 percent.

The Fed’s US inflation expectations also rose. In the statement after last week’s meeting, Fed officials experienced a core inflation rate of 3.7 percent in 2021, compared to the 3 percent estimate in June. Next year, the inflation rate is 2.3 percent compared to the previous estimate of 2.1 percent. Chairman Jay Powell in remarks to Congress said on Tuesday that inflation could remain higher for longer, especially if supply chain problems persist.

Inflation expectations in Europe, the UK and the US may continue to rise with energy prices. Brent crude oil, the global oil standard, rose above $ 80 on Tuesday a barrel for the first time in more than three years. Other goods, including coal, carbon and European gas prices, all reached record highs.

“The predominant driver of long-term returns on global bonds appears to be simply the growing energy crisis,” said Mike Riddell, portfolio manager at Allianz Global Investors.

‘This is not immediately logical, because the energy crisis is likely to be a short to medium-term supply shock and should not cause structurally higher interest rates for the central bank. But the rise in gas prices creates long-term inflation uncertainty, where this extra risk premium is built in [bond yields]. ”

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