The crack that appeared in US and European bond markets about a month ago is a stark reminder of how gains can be rapidly erased when market sentiment turns sour. The value of global fixed income markets dropped by an estimated US$400 billion during this rout. The primary reasons for this sell down are well documented:
- An uptick in oil price to above US$60 a barrel on 5th May raised inflation expectations;
- Concerns over the expected rate hike by the US Federal Reserve;
- USD weakness brought about by slower 1st Quarter growth lead to an unwinding of the Euro carry trade. As investors would have borrowed Euros to buy European government bonds, this added selling pressure in the European bond market;
- The continuing Greek drama and their inconclusive negotiations with the EU, ECB and IMF took some of the shine off investors’ enthusiasm for European assets;
- Negative yielding German bunds that made Bill Gross call German 10-year bunds “the short of a life time”; and
- Reduced bond market liquidity as banks adjust to stricter regulatory requirements.
Prices have since rebounded in global government bond markets as it became clear that there is still no whiff of inflation, the ECB is committed to its asset purchase program and China has joined Japan and Europe in printing money. Nonetheless, this recent rout in global bond markets is a foreshadow of what can happen if renewed inflation expectations, market liquidity concerns, a knee jerk reaction to a US Federal Reserve rate hike and/or a black swan event come together in a perfect storm. Going forward, we expect that any negative pressure on asset prices will see selling momentum gather speed quickly. There remains an underlying fragility to investor sentiment.
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