Bond Market Meltdown Deconstructed: Five Charts That Explain Why

Some extreme positioning and some major changes

There’s Life in the Old Bond Dog Yet: Gartside

More than $450 billion has been wiped out across global bond markets in the past few weeks and, for many people, there doesn't seem to be any particular reason why.

Sovereign-bonds yields had fallen so far that in order for them to make sense, investors would have needed to see persistent deflation and European recessions. For a while, that seemed like a real possibility, as oil went from more than $100 a barrel to less than $50 and many forecasters were predicting $30. Well, that didn't happen, and oil started to rise at the same time as evidence of incipient inflation and economic growth in Europe.

That sparked speculation -- proven to be unfounded -- that the European Central Bank could even end its bond-buying program early. Against that backdrop, holding bonds with yields close to zero made little sense, causing investors to unwind one of the most crowded trades in all of markets. So, next time someone says "we don't really know," don't buy it. Here are a few reasons that explain why.

1. Oil:

Bonds became a favorite place to profit from the market turmoil sparked by crude oil's rapid collapse last year as investor bet it meant an end to the risk of inflation. Now that the price for crude seems to have stabilized, and even rebounded, the threat from the main nemesis of fixed-income investors is renewed.

Brent crude price
Brent crude price

2. Inflation:

The rebound in oil may be sowing the seeds of a very good reason not to own bonds: inflation. Because most bonds' coupon payments are fixed, rising inflation lessens the value of each one of those payments in the future. That didn't matter when it looked like falling oil prices could drag Europe and other parts of the world into deflation, prompting central banks to cut rates and the ECB to launch its bond-buying program. Now, all that central bank action, along with the bounce in oil, may actually be working. Inflation in the euro zone stopped falling last month after going negative at the end of last year.

Euro area inflation
Euro area inflation

3. European Growth:

The early signs of inflation and positive economic growth coming out of Europe is causing increased optimism the currency bloc may actually pull out of its funk. After spending the end of last year slashing 2015 growth forecasts for the euro zone, economists are raising estimates again. As recently as February economists were calling for the euro zone to grow 1.1 percent this year. Now they've raised their median forecast to 1.4 percent, according to a Bloomberg survey.

Euro-area growth forecasts
Euro-area growth forecasts

4. Positioning:

Too many people were invested too heavily in bonds. Data from the Commodity Futures Trading Commission show investors started 2015 with the biggest bet on U.S. government bonds in seven years. By the end of the first quarter, more than half that position was gone.

U.S. Treasury bond futures long positions
U.S. Treasury bond futures long positions

5. Sub-Zero Yields:

Between the ECB's bond buying and the threat of deflation, yields across Europe started to go negative this year, meaning investors were essentially paying for the privilege to lend their money out. That created a spill over effect into bond markets in the rest of the world as investors went in search of a better deal, pulling yields down in those markets too. The average yield across all Germany's debt went negative about three weeks ago. That seems to have been the straw that broke the camel's back. Since then that average yield has climbed to the highest level this year. Yields on about $2 trillion of bonds across 12 countries still linger below zero.

Bloomberg German Sovereign Bond Index yields
Bloomberg German Sovereign Bond Index yields
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