Scott Thiel, managing director, deputy Chief Investment Officer of Fixed Income, head of Global Bonds and Direct Portfolio Management, at BlackRock, comments on recent volatility in the bond markets in the past few weeks and why he expects it to continue.
In the first couple of weeks of April 2015, Germany’s benchmark 10-year government bond (bund) yield looked dangerously close to falling below zero. Then in mid-April, bond yields started suddenly rising – and fast. On 10 April, yields on bunds dropped to just 0.16%. By 11 May, bund yields were up 41 basis points to 0.57%. Over the same period, the yield on UK gilts moved from 1.55% to above 2%.
The severity of such a sharp sell-off brought into focus the build-up in consensus positioning there has been in fixed income over recent months – and how ill-equipped (in terms of trading liquidity) bond markets are to cope when sentiment suddenly reverses.
So what was behind the reversal in thinking that that led to the sell-off? Well, I believe there were three big assumptions investors were making, particularly about Europe, that became challenged:
At beginning of 2015, inflation expectations had been depressed, particularly Europe. An unexpected bounce in the oil price in April reduced the prospect of outright deflation and those inflation expectations were raised. Suddenly, holding negative- or extremely low-yielding bonds made even less sense.
The US and UK were supposed to be tightening monetary policy sooner-rather-than later as their respective economies strengthened. A slew of weaker US and UK Q1 data, alongside European data that surprised on the upside, challenged such thinking and investors became nervous.