Investors have failed to take on board the full implications of the end of stimulus in the US, meaning they could be unprepared for a ratcheting up of bond market volatility.
Sticking to its guns last week, the US Federal Reserve confirmed it would conclude its asset purchase programme, which has largely been responsible for the rise in asset prices since the depths of the financial crisis.
The decision was supported by a more hawkish statement from the Fed and stronger-than-expected annualised economic growth of 3.5 per cent in the third quarter.
But in spite of this, bond prices still rose, signalling potential concerns about economic growth.
Joshua McCallum, senior fixed income economist at UBS Global Asset Management, said he was shocked when he came into the office the day after the Fed’s announcement and wondered if “anyone had read the statements”.
“The bond markets have been abnormal all year,” he said. “But if I had all the data from the year in front of me, I still would not have been able to make the right prediction for the bond markets. They have rallied and there has been no reason for it.”
Stewart Cowley, manager of the Old Mutual Strategic Bond fund, said the bond market did not respond in a normal way to the end of quantitative easing or the more hawkish statement released by the Fed.
“The bond markets just don’t get it,” he said. “The bond market rose in price – that could be a real threat.”
When the bond markets do finally “get it”, Mr Cowley added, the price will change “quickly and viciously” – producing a fall in bond prices that would vindicate his fund’s short position on US Treasuries.
Sandra Holdsworth, investment manager at Kames Capital, said the Fed’s statement was “marginally more hawkish” and the US Treasury market “repriced slightly”.
“In our view this was marginal and all the Federal Open Market Committee did was to reiterate that policy in the future is highly data-dependent and an increase in rates is unlikely for some time,” she said.
“As a result of this data dependency, we would expect an increase in market volatility in the months to come as markets react to economic statistics and try and predict the reaction function of the US Federal Reserve.”
A report by Bank of America Merrill Lynch also noted the end of stimulus in the US was “coinciding with historically low levels of government bond yields and collapsing inflation expectations”.
“Ten-year US Treasury yields are 50 basis points lower today than at the start of QE1, French 10-year yields are the lowest they have been in over 250 years, and economists are cutting inflation forecasts rather than raising growth targets,” the report said.
“All of this is great fodder for the liquidity bears who see QE as a failure, secular stagnation everywhere and warn of great, imminent bear markets in both credit and equities.
“For the bears the recent bout of volatility was merely a warning shot... Coming months will reveal unambiguous evidence that QE has failed to eradicate deflation and a loss of credibility in central bank policy will send asset prices into a tailspin in early 2015.”
David Stubbs, global market strategist at JPMorgan Asset Management, said he did not expect the market to be overly impacted by the end of stimulus in the US.
He thought the Fed would “leave the door open to more QE” but only in a “pretty bad situation”.
Mr Cowley, however, said additional easing should be “avoided at all costs”.
