Bonds: Is It A Sell Off Or Market Correction!

Bonds: Is It A Sell Off Or Market Correction!

bond markets sell off fxcommentGlobal bond markets have recently seen a huge selling that wiped more than $450 billion off the value of global fixed-income markets in three weeks.

In fact, the sell-off started in Europe in late April, and then the contagion moved over the Atlantic to US Treasury bonds and the Asian bond market.

German bond selling began on April 28, causing a remarkable narrow in the yield between German 10-year bonds and Treasuries with the same maturity.

What Happened?

A rally in bund yields was triggered by the strong purchase to securities by the ECB under its 1.1tn QE program that began in March, where it targets 60 billion euros ($68 billion) of bonds a month.

At the beginning, the strong purchase by the ECB created high demand on bonds, thereby pushing up its prices and lowering its yields.

Draghi said QE would run through September 2016, which means the strong demand on bonds would continue for a long period unless the euro area economy shows vivid signs of recovery that prompt the ECB to quit the stimulus program before the aforesaid date.

Since the beginning of April, the ECB has kicked off its securities-lending program that allows banks to temporarily exchange bonds they own for those the ECB has bought under its QE.

Accordingly, the repurchase rates in the euro area dipped to negative territories. This means traders are paying another entity to take their cash so that they can own the securities for a limited period.

It is important to notice that the ECB also buys government bonds and asset-backed debt.

The ECB has mentioned it will buy negative-yielding securities up to its cash deposit rate of minus 0.2 percent.

Investors, however, still opted to hold bonds due to its relative safety, especially amid deflation concerns in the euro area.

The following chart shows the rise German 10-year bund yields over the past month.

German 10-year bond yeild fxcomment

Yields Up

Draghi mentioned by mid-April that he did not think bonds would become scarce, and that his bond buying plans were flexible.

Investors’ concern the euro region is at risk of deflation retreated after consumer prices in the currency bloc stagnated in the year through April, ending a four-month run of declines, amid a rise in oil prices.

Growth prospects for the eurozone have improved, with data showing the 19-nation region quickened its expansion in the first quarter to 0.4 percent from 0.3 percent three months earlier.

Some analysts argue that technical factors such as banks choosing to hold fewer sovereign bonds for regulatory reasons have helped to push yields up.

When the sell off started, the negative yields in the euro area have helped the selling to be even stronger.

Worldwide, the demand on haven bonds retreated with the rebound in crude prices, as it eased deflationary woes and boosted inflation expectations.

However, the narrow in bond yields between U.S. treasury and its European counterparts is probably due to the relative improvement in euro area data compared to U.S. data.

The progress in euro area data, along with the rise in global inflation expectations, has prompted investors to convert from dollars to euros.

The recent bond bubble could be a byproduct of the change in market bets for seeing even stronger dollar.

This interpretation could be valid, as the release of downbeat U.S. consumer sentiment data last week was followed by drop in both dollar and bond yields.

The following chart shows the rise in U.S. 10-year Treasury yield over the past month.

US 10-year Treasury yield fx comment

Market Correction

Some analysts see the latest rise in bond yields cannot be described as a “sell off,” rather it represents a rational market correction than a panic that could impend financial stability or choke off economic recovery.

They believed that following the rise in bond prices, as it has remained overbought for some time, the market faced a shortage of liquidity.

The rally in long-term Treasuries could be reversed once the Fed begins raising interest rates, Fed Chair Janet Yellen said. This increase will lower the price of bonds as more attractive new bonds can be issued.

It is worthwhile to mention, bond yields are the interest rates countries have to pay to borrow on international money markets.

Ahmed Mamdouh

Ahmed Mamdouh, Co-Founder and Head of English Fundamental Analysis at, with 7 years of experience in the financial markets. Mamdouh holds a Master’s Degree in Economics from The American University in Cairo and a Bachelor Degree in Economics from The Faculty of Economics and Political Science, Cairo University.

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