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Sovereign Bonds Head for Biggest Quarterly Slump Since 1987

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This is shaping up as the worst quarter for sovereign bonds in almost 30 years.

The Bank of America Merrill Lynch Global Government Index is down 2.9 percent since the end of March. If it holds, it’ll be the biggest quarterly loss since the third quarter of 1987. The selloff started in Europe as investors balked at record-low yields in Germany, where they were barely above zero for 10-year securities. It spread amid rising speculation the Federal Reserve was preparing to increase borrowing costs this year as the world’s biggest economy improved.

“It seems very much as if it was extreme positioning being unwound,” Simon Smiles, chief investment officer for ultra-high-net-worth individuals at UBS Group AG in London, said in an interview on Bloomberg Television’s “Countdown” with Anna Edwards. “Bonds, in terms of high-grade government bonds, will continue modestly to sell off. We don’t expect anything like the magnitude of the moves we’ve seen recently.”

The benchmark 10-year U.S. yield has increased 47 basis points, or 0.47 percentage point, since the end of March to 2.39 percent as of 7:20 a.m. in New York, according to Bloomberg Bond Trader data. It rose one basis point Friday. The price of the 2.125 percent note due May 2025 was 97 22/32.

Officials around the world are taking unprecedented measures to head off deflation.

The European Central Bank and Bank of Japan are both buying record amounts of government debt to pump money into their economies. South Korea and New Zealand both cut interest rates this week. Inflation erodes the spending power of fixed payments on bonds.

Record Holdings

The Fed’s Treasury holdings are near a record after it concluded its own bond-buying program last year. U.S. policy makers will raise rates in about 5 1/2 months, according to a Morgan Stanley gauge.

Pacific Investment Management Co. said this week it expects U.S. consumer-price growth to pick up and sees value in inflation-protected securities.

The difference between yields on government bonds around the world and inflation-linked securities, a gauge of trader expectations for consumer prices, was 1.34 percentage points, according to a separate Bank of America index. The figure has climbed from this year’s low of 0.99 set in January.

It’s still less than the 2 percent target set by central banks in the U.S. and Japan. The ECB aims to keep inflation below but close to 2 percent.

Americans surveyed by the University of Michigan in May expected an inflation rate of 2.8 percent in the next year. The university is scheduled to issue its June figure Friday.

So while this quarter’s bond rout started with the plunge in Germany, the record-setting loss is now being driven at least in part by the reflation story.

“We’ve come into a bear market for bonds,” said Shane Oliver, head of investment strategy at AMP Capital Investors Ltd. in Sydney. “Deflation fears are continuing to unwind and the Fed is getting closer to raising interest rates. The picture will be one of rising bond yields.”