“We are facing the largest fixed income bear market of all time,” Bank of America analysts wrote in a note this Friday. Money is fleeing from bonds: outflows of funds worth $2.5 billion are estimated, according to data from the consulting firm Epfr collected by Reuters. Losses from the highs range between 50% and 80%. Buying debt at this time is a “humiliating” operation, according to these experts.
When the price of bonds falls, their profitability rises, precisely to attract investors who are most reluctant to invest their capital. In most developed economies, sovereign debt today offers returns that are double the average of the last decade. For example. The yield on 30-year US Treasury bonds this week exceeded 5% for the first time since 2007, a date dating back to the great financial crisis.
The case of the 10-year German bund is also striking. In February 2022, before the war in Ukraine, investors did not care about losing money to put their savings in a safe place, as German debt offered negative yields. Last Wednesday its remuneration exceeded 3%, the highest level in 12 years, when the euro zone was under a speculative attack. Like then, Italy is once again the weak ring in the eurozone. Its risk premium has reached over 200 points.
The market perceives risks in public debt. The two-year US sovereign bond offers higher yields than the ten-year. And it is something anomalous, it should be the other way around. When this happens, statistics say that a recession is soon inevitable, Stefan Hofrichter, chief economist and director of global strategy at Allianz IG, reminds this newspaper. “When soft landings are predicted, in reality they almost always end up being moderate recessions.”
But how did we get to this situation? These days there was a classic market paradox: the data on US employment was unexpectedly good, with job creation and unemployment at historic lows. But what is good news becomes bad news, because the market interprets that given this strength, inflation will take time to fall and the interest rates set by the Federal Reserve (Fed) will remain high for a long time (the planned cut by 2024 it will be postponed), making credit more expensive, slowing down investments and increasing the risks of insolvency. Fed member Michelle Bowman returned this Monday to talk about the need to continue raising rates. The market gives a 50% chance that this will happen at the meeting on November 24.
The tax issue also influences. After Covid, the financing needs of the public sector have increased rapidly, governments have to issue more debt (in the United States they even plan to close the Government due to lack of money), just when central banks are gradually reducing their portfolio of public titles. In these circumstances, the cost of debt is inevitably bound to rise.
Beyond the financial mathematics, there is credibility. The increase in long-term bond yields is also a consequence of the market being distrustful of what will happen with inflation. After central banks said that the rise in inflation would be provisional, many now do not believe the forecasts that it will reach 2% in a couple of years and investors choose to hedge.
“When central banks say they will be dependent on data it means they don't know what will happen. They injected too much liquidity into the system that they will now have to withdraw. Therefore, we cannot exclude further increases in yields and the occasional financial storm that will especially affect pension funds,” warns Hofrichter. David Lebovitz, from JP Morgan, warned these days: “If rates continue to rise there will be a financial accident.” The collapse of Silicon Valley Bank months ago had no systemic consequences. Now many are wondering what the next accident will be like.
