“We are facing the biggest bear market in fixed income of all time”, Bank of America analysts wrote in a note on Friday.
Money is fleeing bonds: an estimated 2.5 billion dollars worth of fund outflows, according to data from the EPFR consultancy collected by Reuters. Losses from highs range from 50% to 80%. Buying debt at the moment is a “humiliating” operation, according to these experts.
When the price of bonds falls, their yield rises, precisely to attract the most reluctant investors to invest their capital. In most developed economies, sovereign debt today offers returns that are twice the average of the last decade. For example, the yield on 30-year US Treasuries topped 5% this week for the first time since 2007, dating back to the Great Financial Crisis.
The case of the 10-year German Bund is also striking. In February 2022, before the war in Ukraine, investors did not mind losing money to put their savings in a safe place, as German debt offered negative yields. On Wednesday, its return topped 3%, the highest level in 12 years, as the euro zone came under speculative attack. As then, Italy is once again the weak link in the eurozone. Its risk premium has reached over 200 points.
The market perceives risks in public debt. The two-year US sovereign bond offers higher yields than the ten-year bond. And it’s anomalous, it should be the other way around. When this happens, the statistics say that a recession is soon inevitable, reminds this newspaper Stefan Hofrichter, chief economist and director of global strategy at Allianz GI. “When soft landings are forecast in reality they almost always end up being moderate recessions.”
But how did we get to this situation? A classic market paradox was experienced these days: US employment data was unexpectedly good, with job creation and unemployment at historic lows. But what is good news becomes bad news, because the market interprets that in the face of this strength inflation will take time to fall and the interest rates set by the Federal Reserve (Fed) will remain high for a long time (the cut planned for 2024 will be postponed), making credit more expensive, slowing down investments and increasing the risks of insolvency. Fed member Michelle Bowman spoke again on Monday about the need to continue raising rates. The market gives a 50% chance of this happening at the November 24 meeting.
The fiscal issue also influences it. After covid, the financing needs of the public sector have increased rapidly, governments have to issue more debt (in the United States there are even plans to shut down the government due to lack of money), just when central banks are gradually reducing its portfolio of public securities. In these circumstances, the cost of debt is inevitably bound to rise.
Beyond the financial math, there is credibility. The rise in long-term bond yields is also a consequence of the market’s mistrust of what will happen to inflation. After central banks said the rise in inflation would be temporary, many now do not believe forecasts that it will reach 2% in a couple of years and investors are choosing to hedge.
“When central banks say they will be dependent on data, it means they don’t know what will happen. They injected too much liquidity into the system, which they will now have to withdraw. Therefore, we cannot exclude further rises in yields and some financial storm that affects pension funds in particular,” warns Hofrichter.
David Lebovitz of JP Morgan recently warned: “If rates continue to rise there will be a financial crash”. The collapse of Silicon Valley Bank months ago had no systemic consequences. Now, many are wondering what the next accident will look like.
