Have there ever been more bearish times for bonds?
Ten-year German bunds were yielding a staggeringly low 0.88 per cent last week.
Yields move inversely to prices, which means any kind of correction on German bund yields back to saner levels would equate to painful losses for owners of the assets.
And because corporate bonds are generally valued on yield spreads above their sovereign equivalents, these losses would of course reverberate up the risk spectrum into investment-grade and even high-yield sectors.
German bunds are now viewed as more or less the only ‘risk-free’ asset in the continent. But part of the reason these yields have fallen to such levels is also the rising expectation that the European Central Bank (ECB) will, sooner or later, have to go on a bond-buying spree – otherwise known as quantitative easing – to force liquidity into the ailing economic zone.
German bunds are now viewed as more or less the only ‘risk-free’ asset in the continentBut, worryingly and significantly, a paper from Deutsche Bank strategist George Saravelos last week predicted the opposite would occur.
He pointed to Europe’s giant current account surplus – the region is exporting far more goods and services than it is importing – and the fact Europeans are saving too much money rather than investing it.
At roughly $400bn (£247.2bn) a year, the vast surplus – which reflects poor domestic demand in the region – would be the biggest in the history of financial markets if sustained, he said.
“Europeans will drive international capital flow trends for the rest of this decade. Europe will become the 21st century’s largest capital exporter… [and] a surplus on the current account implies capital outflows elsewhere,” said the strategist.
The problems will surface, he predicts, when ECB monetary easing policies depress yields further.
They will plunge so low that European investors will flock to foreign capital markets in search of returns, leading to some of the largest capital outflows in the history of financial markets, he concludes.
Outside of Europe, 10-year US Treasuries are yielding 2.3 per cent and UK gilts are at 2.23 per cent – both extremely low.
These currency zones are facing up to the opposite issue. The US Federal Reserve is phasing out its quantitative easing efforts and both nations’ central banks are expected to raise their rates in the not-too-distant future.
Jupiter’s strategic bond star Ariel Bezalel last week told us he had gone sharply bearish on his portfolio, warning of volatility ahead.
Meanwhile, Franklin Templeton’s bond giant Michael Hasenstab has been using various complex currency and credit strategy overlays to adopt a negative correlation to US Treasuries.
What does all this mean?
At the moment, it looks like you’d have to be bonkers to buy bonds.
John Kenchington is editor of Investment Adviser
