Bond Markets

30 Oct 2019

As we observed in the Background section, the confluence of trade tension and deterioration in global growth prospects prompted adoption of supportive accommodation by Central Banks through easier monetary policy; this drove bond yields through the lows previously attained in 2016 and, in a number of countries, inverted curves, an outcome in which Governments could borrow funds more cheaply for ten years than for two.

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Investors frequently interpret such a pattern as a signal of rising recession risk and in many instances as a harbinger of recession itself.  This cautious tone was reinforced by the weakening of the Chinese currency the renminbi which reached multi-year lows at more than 7.1 versus the US dollar, suggesting that one of the largest contributors to global growth was in need of stimulus via a more competitive exchange rate.
 
During the quarter there were 29 separate interest rate reductions from central banks, a material acceleration from the seven recorded in the previous quarter and only one during the first three months of the year.  The attenuated concerns over global free trade, given President Trump’s escalating friction with China and his widening of tariffs to include a number of European goods, meant that Central Banks felt impelled to loosen policy.
From 19 countries who represent the major economies of the advanced and developing world, monitored by the economics team at JPMorgan, not a single one is experiencing inflation above the target set for their Central Bank.
 
They felt able additionally to justify such actions because there remained scant evidence of any escalating upward pressure on inflation; though labour markets were tight in the US, Japan and the UK and wage growth had accelerated slightly ahead of consumer prices, this had not led to any second round effects.  Indeed of 19 countries, representing the major economies of the advanced and developing world, monitored by the economics team at JPMorgan, not a single one is experiencing inflation above the target set for their Central Bank.

Negative sovereign bond yields becoming commonplace

Negative sovereign bond yields becoming commonplace

Source: Bloomberg September 2019

As the chart above shows, sovereign bonds across a broad range of countries and of many different maturities stood at negative redemption yields at the end of September: the record amount of $13.5trn of bonds offering investors negative yields, that we mentioned in our last Review, expanded by a further $3trn at one stage during the quarter.   
$16.5trn
of bonds offering investors negative yields
The returns provided to investors were substantial from such moves and remarkably out of kilter with the defined payoffs from bond investments; for example an investor purchasing a 10yr German bond a year ago knew they would receive 6.7% return in total over that entire forthcoming decade, whereas the movement in yields meant they received more than 12% in the first year alone, ensuring a loss of more than 5% of their capital if they continue to hold the investment for its remaining nine years of life.
 
Clearly bond investors have two options from which to choose, namely to remain as investors until the final redemption or to sell to another purchaser in the meantime, who may have different objectives (such as a Central Bank) or indeed a flawed view of value.  Many investors will find such circumstances perverse and yet the adherence to benchmarks and renewed purchases by Central Banks inhibit the selling that should logically ensue. Other sovereign and inflation-linked bonds exhibited similar patterns and corporate bonds also enjoyed good returns, though (and quite logically) less remunerative than at the sovereign level.

Capital returns to a sterling investor

Capital returns to a sterling investor

Source:Datastream

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