IN TODAY'S bond market, it seems as if no price is too high.
And no yield, as a result, is too low. Roughly US$15 trillion of debt globally have sub-zero yields, yet investor demand shows no signs of abating.
In Austria, government bonds due next century now sell for almost twice their face value. In the US, the 30-year bond rally is pushing yields towards modern-day lows. And Pimco has declared it's no longer "absurd" to think about negative yields reaching the Treasury market too.
All year long, investors have been piling into haven assets on worries about trade and the global economy. Yet even after Wednesday's respite, the sheer magnitude of the rally in recent days, especially in bonds with longer maturities, has been nothing short of breathtaking. It began on July 31, after the Federal Reserve disappointed traders looking for more signs of monetary easing. Then, it accelerated last week after President Donald Trump escalated his trade war with China, which sent stocks worldwide into a swoon.
While you might argue the bond market has become unhinged, investors seem to have made up their minds: US-China trade tensions are pushing the world economy towards a recession, and central bankers need to act fast. "Everyone is trying to rush for the exits at the same time, so there's a yield-suck vortex that is happening," particularly in longer-term sovereign debt, said Chirag Mirani, the head of US rates strategy at UBS.
It's not hard to see why the longest-maturity government bonds have led the advance this year. In a world of ultra-low rates, they offer the highest returns from a safe asset. And with little inflation to eat into returns and the global economy growing weaker by the day, it's a no-brainer - even if yields are minuscule on an absolute basis.
That, in effect, has made what was once unimaginable in the bond market, commonplace. This year alone, Austria's government bonds due in 2117 have returned almost 70 per cent, data compiled by Bloomberg show. They now trade at 191 euros, well above their face value of 100 euros, and yield just 0.77 per cent. Meanwhile, yields on every single issue in Germany's government bond market, from one month to 30 years, have fallen into negative territory.
Demand for 30-year US Treasuries have been so strong that yields fell as low as 2.1216 per cent on Wednesday, just shy of the lowest level since the Treasury began regular sales in 1977. What's more, its yield briefly slipped below the Fed funds effective rate, the interest rate that the Federal Reserve targets when it conducts monetary policy.
The downward spiral in yields may have caught some flat-footed. Franklin Templeton's short bond position in its flagship US$33 billion Global Bond Fund, run by famed bond manager Michael Hasenstab, deepened last quarter, according to filing published in mid-July. And just last month, the firm's chief investment officer, Sonal Desai, warned investors of the risk that bond yields could rise, and do so very quickly.
Even strategists who have regularly called for lower yields have rushed to cut their outlooks. This week, HSBC's Steven Major slashed his year-end German bund forecast to -0.8 per cent from -0.2 per cent and US 10-year yield to 1.5 per cent from 2.1 per cent.
"The already epic global bond bubble continues to inflate," said Peter Boockvar, chief investment officer at Bleakley Financial. "It's really scary to watch." Mr Trump hasn't helped matters. Last week, he announced new tariffs on imported Chinese goods, to take effect on Sept 1. China responded by allowing the yuan to fall and halting imports of US agricultural products. Then, he turned up the rhetoric by designating China a currency manipulator. He also lambasted the Fed, once again, for not doing more to support the US economy.
While bonds have soared, stocks have stumbled. Since the Fed announced its quarter-point rate cut, the S&P 500 index has fallen more than 3 per cent. And with the odds of a protracted trade war on the rise, Wall Street predicts the central bank will have to cut even more. That includes Goldman Sachs, which doesn't see a US -China trade deal before the 2020 US presidential election and says the Fed will lower interest rates twice more this year. "The Fed under-delivered with their cut last week, which we saw as a policy error," said Peter McCallum, a fixed-income strate gist at Mizuho. "They will have to do more easing." On Wednesday, Chicago Fed President Charles Evans said developments since the rate cut may present headwinds to the economy.
Of course, not everyone thinks the sky is falling. Rather than signalling an imminent downturn, Omega Advisors' Steven Einhorn says that low yields are a natural result of years of quantitative easing, excessive global savings and demographic changes, among others.
"The bond market is disconnected, in my opinion, from fundamentals on growth and inflation," he said. "Low Treasury yields are not indicative of a coming US recession. Ditto for sovereign yields in the eurozone." Inflation has remained stubbornly below central bank targets and the bond market is pricing in even less consumer price pressures in the years ahead. Some traders in money-market derivatives have even started betting that the Fed's policy rate will be below zero in 2022.
"The relentless fall in inflation expectations is crowding out other data, and the Fed has little choice but to return to the slippery slope of accommodation," Pavilion Global Markets said in a note on Wednesday. "The result is a constellation of potentially explosive US Treasury demand." BLOOMBERG
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