Historic global bond market crash threatens to liquidate the world’s busiest trading, says Bank of America
Global government bond markets are stuck in what Bank of America securities strategists call one of their biggest ever bear markets — which in turn threatens the ease with which investors will be able to exit the world’s busiest trade, if necessary.
These deals include long positions in the dollar, US technology firms and private equity, said strategists Michael Hartnett, Elias Gallo and Myung Ji Jong. Bonds are generally considered to be one of the most liquid asset classes available to investors; Other analysts said that once the liquidity there dries up, that portends bad news for every other form of investment.
Financial markets have yet to determine the worst outcome for inflation, interest rates and the economy around the world, although global stocks tumbled along with bond selling in the US and UK on Friday. Dow Industries DJIA,
It fell more than 700 pips at its lows, dragging it into bear market territory, while the S&P 500 SPX,
It threatened to take out the lowest closing level in June.
US yields were trading at their highest levels in several years. Meanwhile, government bond prices in the United Kingdom, Germany and France rose at the fastest rate since the 1990s, according to BofA Securities.
“Inflation/rate/recession shocks are far from over,” Bank of America strategists wrote in a note Thursday, as well as the bond collapse in recent weeks “meaning spikes in credit spreads, and equities lows yet to emerge.” They said investor sentiment was “undoubtedly” the worst since the 2007-2009 global financial crisis. Analysts also see the Fed funds rate, Treasury yields and the US unemployment rate all heading towards between 4% and 5% over the coming months and quarters.
Government bonds have had losses of 20% this year, as of Thursday — the worst losses since 1920, according to BofA. For the whole of 2022, global government bonds are on track for one of their worst performances since the Treaty of Versailles, which was signed in 1919 and entered into force in 1920 — which set the terms of peace at the end of World War I. Bond prices move in opposite directions, so higher yields reflect lower government debt prices.
Liquidity is important because it ensures that assets can be bought or sold without significantly affecting the price of that security. Without liquidity, it is difficult to convert an asset into cash without losing money against the market price.
Government bonds are the most liquid assets in the world, so “if the bond market doesn’t work, there are really no other jobs in the market,” said Ben Emmons, managing director of global macro strategy at Medley Global Advisors in New York.
“The rising yields continue to drain credit and will hit the global economy hard,” Emmons said by phone on Friday. “There is a danger of a ‘sell-everything’ market that looks like March 2020, as people withdraw from the markets amid greater volatility and find that they cannot actually trade.
Friday’s historic bond sale in the UK, spurred by eroding investor confidence fueled by the government’s mini-budget plan, exacerbated concerns about deteriorating liquidity, particularly in the normally safe Treasury market.
Read: The next financial crisis may already be maturing – but not where investors expect
In the US, Federal Reserve officials have shown a willingness to crack something at higher rates – whether it’s in the financial markets or the economy – to bring down the most intense wave of inflation in the past 40 years.
Part of the drop in global bond prices this month “is the real fear that central bank rallies are mounting in a competitive race to preserve currency viability and not become the last country to hold a bag of hyperinflation,” said Jim Vogel, executive vice president. Head at FHN Financial in Memphis.