How Central Bankers Are Twisting Classic Bond-Investing Logic

Fed Ponders 'What Ifs' in Wrestling With Rate Hike

The more central banks mess around with global bond markets, the more you have to question how you invest in bonds.

Think safe-haven debt, such as U.S. Treasuries, will provide a hedge against losses on stocks? Not always. Or that central bankers really have control over borrowing costs? Or that you ought to get paid to lend money to Germany, Switzerland, France and Belgium? Nope, on both counts.

The latest market turmoil is underscoring the difficulties of relying on conventional wisdom at a time when bond markets are dominated by the trades of Chinese, European and U.S. policy makers. While stocks globally just underwent a plunge that eliminated $5 trillion of value in less than two weeks, bonds acted in some surprising ways.

Treasuries, often a haven for investors fleeing riskier assets, actually lost value after China rocked markets by devaluing its currency to stimulate growth. Longer-term U.S. government Treasuries have declined 2.3 percent since Aug. 17, according to Bank of America Merrill Lynch index data.

This doesn’t make sense from a purely economic standpoint, since the prospect of slower growth should make these securities more attractive, not less. But there’s another force at play. China, the world’s second-biggest economy that’s accumulated trillions of dollars of foreign assets since 2003, is now selling some of those securities, including Treasuries.

‘Huge’ Outflows

“The potential for more China outflows is huge,” Deutsche Bank AG strategist George Saravelos wrote in an Aug. 26 report. “Real yields should move higher, inflation expectations lower.”

Meanwhile, the same slowdown in China’s economy that spurred the nation to sell Treasuries is also prompting the U.S. Federal Reserve to consider delaying its first interest-rate hike since 2006.

The decision to begin the normalization process at the September Fed meeting “seems less compelling to me than it was a few weeks ago,” Federal Reserve Bank of New York President William C. Dudley said in an unscheduled statement Wednesday.

That supported stocks, as would be expected. Yet even as derivatives traders were pushing back expectations for when the Fed would likely raise rates, yields on two-year Treasuries rose.

Over in Europe, logic has been turned on its head, with investors receiving negative yields on two-year bonds in a number of its major economies.

That might make sense if Europe was about to sink into a recession, but the European Central Bank has said it’s willing to expand stimulus efforts to spur growth. That may leave traders with bigger losses than they’re pricing in right now.

So if you think you know what’s happening next in the bond market, these recent moves mean you might want to think again.

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