PMC Weekly Review - June 12, 2015
The sharp rise in global 10- and 30-year yields over the past two weeks has stunned the markets. In the first eight trading days of June, the Treasury yield curve has shifted 15-40 basis points higher: 10-year Treasury yields rose 38 basis points, and 30-year yields increased 34 basis points. Nor have rising rates been confined to the U.S. German 10-year yields more than doubled, from 0.48% to 1.06%. In the U.K, they jumped from 1.81% to 2.19%; in Italy they soared from 1.88 to 2.41; and in Spain, they spiked from 1.84% to 2.38%. Is this sell-off in global government bonds just more volatility as the market participants try to find any sort of value or yield in a market glutted with liquidity? Or, rather, does it reflect an adjustment by those same participants who are anticipating the backing away from several years of massive quantitative easing (QE) and toward eventual normalization of global monetary policy?
June’s sharp movement in yields is essentially in line with the volatility we have seen in both directions so far this year. German yields fell from 0.54% at the beginning of the year to 0.05% (a 90% drop) before climbing back. Italy had a similar story: yields were cut in half (from nearly 2.00% to just over 1.00%) before ending May at levels near where they were at the beginning of the year. Spain hasn’t experienced quite as much volatility: yields fell from 1.61% at the beginning of the year to 1.05% before moving back up. Yields in the U.K had a much more volatile five months. They began the year at 1.76%, moved down to 1.33% in February, and rose to nearly 2.00% in early March. By mid-April, they fell back to roughly 1.60%, before settling at 1.83%, near their break-even level, at the end of May.
From a fundamental perspective, several months of stronger-than-expected economic data from the Eurozone, including Gross Domestic Product (GDP) growth and modest increases in inflation, may have investors on edge as to whether the European Central Bank (ECB) will cut its QE program in the near future. After all, the negative nominal yields on short and intermediate government bonds that became common in March and April only make sense if there is a large forced buyer (ECB) and a relatively limited supply. In addition, the ECB may be putting pressure on European banks to increase cash reserves, which also would contribute to the sell-off. At the same time, weak to tepid economic numbers out of the U.S. have, most likely, pushed the first Fed rate hike to September, at the earliest. This perception has led to the dollar giving back some of its gains against the Euro, and retracing virtually all of its gains against the pound. If this trend continues, treasuries will be less attractive to global buyers, and the expected demand on the longer end of the curve will be reduced. Although signs of actual inflation above the Fed’s stated 2% target remain scarce, the combination of continuing solid job growth data and slowly increasing wage growth are key long-term components in the timing of its rate hike decision.
As it usually does, the answer to the question of what is triggering the sell-off in 10-year Sovereigns sell-off most likely borrows a little bit from both camps. As has been the case since the beginning of the year, the consensus among the institutional managers we talk to is for continued high levels of volatility in the fixed income markets through at least the end of this year. Many investors who were burned (or at least singed) in the sharp rate rise at the end of 2013 are likely to remain highly cautious, and will be quick to sell at the first sign of rising rates. This will create a negative feedback loop, as their collective sales will contribute to falling prices and rising rates. Staying invested with managers who have a focused, long-term outlook most likely will have served investors best once the dust eventually settles. 1
1 All yield and other market data from SIX Financial Information via Marketwatch.com
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