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PERSPECTIVE

Sovereign bond yields show the world is back in crisis mode

30-year US yields slide through 1.5% for the first time on Friday, as fears over the spread of Covid-19 spook investors

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An electronic stock board at the Shanghai Stock Exchange. The unusually large move in Treasuries on Friday sent the S&P 500 Index futures tumbling, and pulled down equity benchmarks across Asia.

SOVEREIGN bonds are emphatically demonstrating their appeal as a last refuge for investors spooked by another global crisis, this time sparked by the crippling impact of the coronavirus.

Government debt racked up further historic milestones on Friday, with 30-year US yields sliding through 1.5 per cent for the first time and China's 10-year rates hitting the lowest since that country was battling deflation in 2002. Australian 10-year notes have lost about half the nominal yield they had just weeks ago, as that market anticipates the introduction of quantitative easing (QE).

The moves were so powerful they risk stoking alarm in other markets, from equities to credit. The unusually large move in Treasuries for an Asian morning session sent S&P 500 Index futures tumbling, and pulled down equity benchmarks across the region. The gains also mean that where yields bottom from here is anybody's guess.

"Zero percent yields are no barrier to any bond market in the developed world right now," said Shaun Roache, chief Asia-Pacific economist at S&P Global Ratings. "It's an insane market - investors are re-defining the idea of risk distribution."

News on the coronavirus epidemic and policy makers' responses - including the Federal Reserve's emergency 50 basis point interest-rate cut on Tuesday - have swung stocks one way and the other. But for bonds it's essentially been a one-way street.

Ten-year Treasury yields, arguably the single most powerful global financial-market metric, have cratered the past three weeks, down about 75 basis points. That's a scale unprecedented since the aftermath of the bankruptcy of Lehman Brothers Holdings Inc in 2008.

They were at 0.83 per cent as of 3.20 pm in Tokyo, with 30-year Treasuries at 1.44 per cent. China's 10-year notes yielded 2.64 per cent, against about 3.15 per cent at the start of the year.

Mr Roache said traders are now discounting a return of QE by the Fed and an expansion in Bank of Japan asset purchases. Money markets are pricing about a 90 per cent possibility that the European Central Bank will lower its deposit rate by 10 basis points next week.

In Friday's wild rally in Asian hours, traders pointed to a lack of liquidity exacerbating the size of moves. Sharp gains in US ultra-long bond futures also caused circuit breakers to kick in, briefly halting trade.

But the trend has been as inexorable as the spread of the coronavirus itself, with new waves of infections and markdowns in growth forecasts driving fresh inflows to risk-free securities.

It's driven the global supply of bonds with negative yields to US$14.4 trillion, up by well over US$3 trillion since mid-January, before the epidemic became apparent in central China. Last August's record - almost US$17 trillion amid a rough patch in the US-China trade war - stands to be blown away should a swathe of the Treasury market see nominal yields drop below zero for the first time. Two-year rates have little more than half a percentage point remaining.

"The race to zero is just flying off the handle," said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd. "Trying to draw a line in the sand for 10-year yields when markets are slammed by fanatical hopes of Fed action and pandemic fears in turn may be a fool's errand."

It's all been a dramatic showcase for the benefits of bonds as a hedge in portfolios, after that traditional allocation strategy faced questions less than two years ago. The Bloomberg Barclays Global Aggregate index of bonds has returned 4.6 per cent since the year began, versus minus 6.7 per cent for the MSCI All Country World Index. Gold, another once-maligned hedge, is up 7.5 per cent.

It's not just been developed-nation bonds, or even those in major currencies, that have benefited from haven demand. Yields on local-currency emerging market sovereigns hit 3.72 per cent on Wednesday, a Bloomberg Barclays index showed. That's a record in the gauge's history, going back to 2008. (Friday prices are pending.)

At least some of the global rally is bound to be retraced once the epidemic crests. But if the past two decades of precedent hold, benchmark yields aren't likely to return to the highs from before the latest policy-easing cycle. For 10-year yields, the high-water mark was 3.26 per cent in October 2018.

"A bottoming out in US rates will come when all the bad news is priced in, said Eugene Leow, fixed-income strategist in Singapore at DBS Group Holdings Ltd. But "a 3 per cent level for the 10-year yield is very far away. Even if we get a swift rebound, the Fed will only hike by next year." BLOOMBERG