Inflation in Check Shows Bond Selloff Unlike 1994 Rout, BIS Says

Subdued inflation expectations are helping to prevent this year’s selloff in government bonds from deepening into a rout comparable to that seen in 1994, the Bank for International Settlements said.

Yields on government securities are still low by historical standards because increases since the Federal Reserve said it could cut monetary stimulus haven’t immediately been accompanied by higher central-bank rates, the Basel, Switzerland-based BIS said in its latest Quarterly Review today. That’s helping to sustain demand for higher-yielding assets, it said.

“The recent selloff did little to undermine the relative appeal of riskier securities, which asserted itself in the second half of 2012 and persisted through the third quarter of 2013,” the BIS said in its report. “This extended the squeeze of credit spreads and fueled strong issuance of bonds and loans in the riskier part of the spectrum.”

Treasury 10-year yields have jumped 84 basis points, or 0.84 percentage point, since Fed Chairman Ben S. Bernanke said May 22 that the central bank could start slowing the pace of its bond purchases this year. They were at 2.89 percent at 5:35 p.m. London time on Sept. 13, compared with a 10-year average of 3.53 percent. At the same time, investor expectations of inflation as measured by bond trading dropped, leaving the central bank reiterating that interest rates will stay near zero.

A 2 percentage-point jump in the Treasury yields in 1994 was accompanied by a 2.5 percentage point increase in the Fed’s target rate to 5.5 percent.

Inflation Expectations

In 1994, long-term nominal yields rose together with policy rates and the potential for higher consumer prices, the BIS said. “By contrast, inflation expectations were largely unchanged in the second and third quarters of 2013.”

Treasury 10-year yields are still almost 2 percentage points less than the average in the decade prior to the collapse of Lehman Brothers Holdings Inc. in 2008, supporting demand for assets with higher returns.

Yields on German 10-year bunds, Europe’s benchmark securities, closed at 1.98 percent on Sept. 13, versus a five-year average of 2.48 percent.

The Markit iTraxx Crossover Index of credit-default swaps linked to 50 high-yield companies fell on Sept. 11 to the least since May 22. The index typically drops as investor confidence improves and rises as it deteriorates.

Low core-government-bond yields are “perpetuating the relative appeal of higher-yielding asset classes,” the BIS said. Demand for those assets is “a phenomenon reminiscent of the exuberance prior to the global financial crisis” that broke out five years ago, it said.

The BIS was formed in 1930 and acts as a central bank for the world’s monetary authorities.

To contact the reporter on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net

To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net

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