Bond Traders Unnerved by Surprise Selloff Ahead of Pivotal Week

Bond Selloff Deepens as Draghi Disappoints Markets
  • Global sovereign debt tumbles as Draghi damps QE speculation
  • Traders run gauntlet of debt auctions, economic data next week

Government debt from the U.S. to Germany to Japan plunged this week, shattering a calm that pervaded bond markets for months, as concern escalates that central bankers globally are reconsidering the efficacy of extending monetary stimulus that’s driven yields to record lows.

Longer-dated securities, which have been outperforming in recent months, led losses, with 30-year Treasuries recording their biggest two-day selloff in more than a year. ECB President Mario Draghi said Thursday that officials didn’t discuss an extension to the institution’s bond-purchase plan, disappointing investors who had been speculating that more stimulus was imminent. In July, Bank of Japan Governor Haruhiko Kuroda opted against expanding the nation’s unprecedented easy money policies, fueling speculation the BOJ plans to change its asset-purchase strategy.

The drastic decline in bond prices this week caught most investors off guard, serving as a reminder that there are limits to the global easing that helped push yields on more than $9 trillion of developed-market sovereign debt below zero this year. The lack of commitment from Japan and Europe to increase their asset-purchase targets threatens bond bulls who face potentially higher interest rates in the U.S. as soon as this month. Treasury 10-year yields rose to the highest since June on Friday as German 10-year bund yields turned positive for the first time since July.

Calm Shattered

“The market was very complacent -- once we did get moving, people were scrambling to hedge,” said Timothy High, U.S. strategist at BNP Paribas SA in New York, one of 23 primary dealers that trade with the Federal Reserve. “The cobwebs of the market have been shaken loose."

The longevity of the selloff hinges on several events in the next two weeks. The U.S. will flood the bond market with issuance on Sept. 12 with simultaneous auctions of three- and 10-year notes, the first time this year that two fixed-rate note sales occur simultaneously. Economic data next week include reports on retail sales and consumer prices. Fed officials meet Sept. 20-21 to decide the path of U.S. interest rates.

Treasury 30-year bond yields rose 12 basis points, or 0.12 percentage point, to 2.39 percent this week, the biggest increase in five weeks. The price of the 2.25 percent security due in August 2046 was 96 29/32.

The difference between yields on Treasuries due in two and 30 years, a gauge of the yield curve, widened to 161 basis points, the most on a closing basis since Aug. 3.

"We’re seeing the central-bank policy uncertainty translate itself into steeper yield curves, which at the end of the day isn’t going to be stimulative," said Robert Tipp, chief investment strategist for the fixed-income division of Prudential Financial Inc. in Newark, New Jersey. "The end result is some retracement of the increase in yields, and Treasuries stabilizing. But it’s unclear right here how far yields are going to go before that happens."

Hedge funds and money managers reduced their net bullish bets on Treasury bond futures to 24,134 contracts in the week to Sept. 6, the lowest since March, according to data from the Commodity Futures Trading Commission.

Fed policy makers are looking to raise interest rates after liftoff from near zero in December. Officials entered 2016 expecting four hikes this year but have since pared projections amid signs of sluggish global economic growth.

Futures pricing indicates a 30 percent chance of tighter policy this month, according to data compiled by Bloomberg. The probability of a hike by year-end was 60 percent. The calculations assume the effective fed funds rate will average 0.625 percent after the central bank’s next boost.

Fed Path

Boston Fed President Eric Rosengren struck a more hawkish tone Friday, saying waiting too long to raise rates may lead to the U.S. economy overheating.

"In terms of what the Fed’s trying to do, they need to get to a more balanced probability around the meeting -- otherwise there’s no point in meeting if everyone’s absolutely sure they’re not going to do anything,” Steven Major, global head of fixed-income research at HSBC, said in an interview with Bloomberg Television. “If they did want to hike, the last thing they want is a huge market shock, so the Fed’s speeches are being used to manipulate the probabilities a bit higher. But frankly, I reckon, nothing will happen."

While yields are still lagging below historical averages, they’re quickly rising from record lows reached earlier this year, recalling the bond rout of 2015, which saw German 10-year yields climb more than a percentage point in less than two months. Sovereign bonds in Germany, the U.K. and Japan, markets that have help drive the global bond rally this year, also saw losses this week.

"There’s a big move in the market, but it’s way too way premature to believe that central banks have reached the end of their line in policy making," said Krishna Memani, chief investment officer at Oppenheimer Funds Inc., which oversees $223 billion. "Once you get beyond these central-bank meetings, the overall economic condition and global deflationary environment reasserts itself."

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