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'Brutal' bond market volatility as fears of deflation fade

Extreme volatility has hit European bond market

Russell Lynch
Friday 08 May 2015 12:03 BST
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Extreme volatility has hit European bond markets
Extreme volatility has hit European bond markets

Extreme volatility has hit European bond markets as fading deflation fears prompted an investor stampede out of government debt. The dramatic shift in sentiment came little more than three months after January’s €1.1trn (£816bn) quantitative easing programme from the European Central Bank fuelled a rush to buy up the debt of countries like Germany and France.

The buying spree drove the German government’s effective cost of borrowing for 10 years to an unprecedented low of 0.075 per cent in late April, as traders bet on the ECB action propping up prices. Countries across the single-currency bloc also saw borrowing costs fall sharply as yields – which move in the opposite direction to bond prices – slumped.

But German bunds, one of the world’s safest assets, were on course for their biggest weekly decline in a decade after another sell off. Yields were up briefly as high as 0.78 per cent in trading, although they then fell back suddenly to 0.58 per cent.

Yields on French 10-year debt have now roughly doubled to 0.9 per cent in the past week, while Spanish and Italian borrowing costs also moved close to 2 per cent. Several European banks, including German Landesbank NordLB, postponed corporate debt sales in the turbulent conditions.

The most savage turn in the bond market has occurred since 29 April, when inflation figures showed the Eurozone moving out of deflation territory, strengthening hopes that the region can avoid a sustained and damaging period of falling prices.

Oil prices are off February lows while growth prospects for the Eurozone have also been marked up by the IMF and the European Commission. Investors have wearied of vanishing returns while rainmakers like Janus Capital’s Bill Gross have also made high-profile interventions. Two weeks ago, Mr Gross called the 10-year German bund the “short of a lifetime.” Richard McGuire, head of European rates strategy at Rabobank, said: “The move is brutal. Valuations in bond markets were at extreme levels.”

Conditions have been exacerbated by regulatory pressure on bank balance sheets reducing the amount of trading, leading to more volatile moves, according to David Page of AXA Investment Management. He added: “We are seeing a lower level of liquidity and that is something that central bankers have raised some concerns about.”

Mr Page said looming bond sales would keep up the selling pressure. “European bond issuance had been less than the €44bn a month being bought by the ECB, but in May, countries will be issuing just over €90bn creating excess supply.”

The eurozone bond sell-off – also driven by speculation that the ECB could wrap up QE early – has fed through to UK gilts, pushing the cost of borrowing for 10 years above 1.9 per cent. “There is little to suggest the rise reflects election concerns,” Capital Economics’ Samuel Tombs said.

In the US, a looming interest rate rise by the Federal Reserve, possibly as soon as June, has also kept up the selling pressure on US Treasury bonds. Chairman Janet Yellen flagged up the potential for a “sharp jump in long-term rates” this week when the Fed eventually moves, giving investors another reason to sell bonds. Mark Holman, chief executive of bond specialist TwentyFour Asset Management, said: “This is the Fed managing the market ahead of lift-off.”

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