On Thursday we witnessed the culmination of what has been a weeks-long German Bund rout. At one point yesterday, yields on German 10s hit 77bps, up from below 10 in mid-April. The severity of the move has taken some (but certainly not us) off guard. For instance, Bill Gross — whose “short of a lifetime” call might have ironically been the catalyst for the sell-off — appears to have underestimated just how illiquid the market has become, because as we reported on Thursday, the Janus Unconstrained Bond Fund had taken a few rather large positions by the end of March which seemed to indicate that Gross was not anticipating his ‘big short’ call to play out so quickly. As we noted, all of this is the inevitable consequence of central bank actions which have quite literally broken the markets, meaning the last vestiges of “efficiency” went out the window a long time ago. His Deutsche Bank’s Jim Reid with more:
A few weeks ago it was interesting to hear Jamie Dimon's remarks about last year's flash crash in US treasuries being a ‘1 in every 3 billion years or so’ event. Well on his abacus the moves in bunds yesterday couldn't have been too far away from this. We closed pretty much where we opened at 0.588% but this masked a big lurch higher in yield to 0.775% intra-day. Indeed, 3 weeks ago 10 year bunds hit a low of 0.048% intra-day with the vast majority thinking it only a matter of time before they'd cross through zero. The scale of the move yesterday will likely add to the debate about liquidity in a regulation heavy post crisis world as there was little fundamentally to justify such volatility.
So, as investors and traders ponder what’s next for the financial world’s safe haven asset par excellence, and as everyone from the world’s most famous bond traders to the ECB tries to comprehend how the market could have possibly become so thin so fast, we bring you a bit more in the way of visual proof that central planners have become the world’s greatest bubble blowers.
Here's a bit more color from Barclays:
Since 20 April (ZH: the day before Gross' short call), the German bund yield has jumped nearly 50bp, one of the sharpest two-week rises in history. In the past 15 years, a rise in yields of this size has only happened twice – in mid-1999 and again in late-2011, as the ECB began to shore up bank funding issues in the midst of the eurozone crisis. Given that roughly less than 5% of participants in our last Global Macro Survey expected bund yields above 50bp by the end of June (we are at 54bp today; nearly one third of the survey expected bund yields below zero), it is likely this bund rally has caused a great deal of dislocation for fixed income investors.
And as we noted just four days ago, we've seen something a bit like this before:
While Draghi keeps buying, the move over the last week is 'almost' unprecedented in bond market history. We says 'almost' because we have seen this before - a sovereign issuer with an extremely low yielding bond suddenly see their bond market collapse... Japan 2003 (when Greenspan cut rates less than expected).
Barclays also sees a possible parallel:
While any comparison to history must be viewed with caution, the bund sell-off does bear some resemblance to a similar episode in the JGB market in June 2003. To start, the pattern of yield changes before and after the bottom looks strikingly similar (Figure 1). Moreover, in June 2003, the JGB yield was touching an all-time low – 45bp at the time (it hit a new all-time low of 20bp this past January). Just ahead of the current rally, bund yields hit a record low of 5bp in mid-April. As in 2003, the current German bund sell-off served as a reminder of how tightly linked global fixed income markets can be, especially at the longer end of the curve (Figure 2). While a poor auction for longer-dated JGBs initially triggered the global fixed income sell-off in 2003, the main fundamental driver is believed to be a less dovish Fed statement a few weeks later. This time around, more hawkish Bank of England minutes initially triggered the global bond market sell-off, although the sell-off has been very much bund-led ever since. Meanwhile, as in 2003, today the Fed is signalling to markets that an end to ultra-accommodative monetary policy is not far off. Finally, both the 2003 and 2015 episodes were preceded by periods of unusually low volatility in fixed income markets, which almost certainly exacerbated the turn in the trend.
If history is indeed repeating itself in global fixed income markets – and we would emphasize this is not a conclusion we’d be willing to make with an analysis this simple – then there is good and bad news for global investors. Let’s start with the bad news. Within six months of the bottom in June 2003, JGB yields had jumped 110bp and losses on the 7-10yr sector of JGB market were nearly 8% – the largest cumulative loss in longer-dated JGBs in the past 15 years. Moreover, for those hoping the euro’s recent rally is just a pause in a longer-run downtrend, the June 2003 JGB bottom also marked a local bottom for the trade-weighted yen – it rallied 8% in the following 3-4 months (Figure 3). The good news is that risk assets saw the 2003 global fixed income sell-off as a correction from excessively low yields, rather than something more menacing. Indeed, despite the 8% loss on JGBs, Japanese equities rallied some 40% over the following year (Figure 4). For asset allocators, perhaps the most important lesson from 2003 is that ultra-low bond yields should eventually trigger flows out of fixed income and into equity. Indeed, there are signs this is happening already: the relative outperformance of equities vs. bonds is by far the biggest asset allocation theme of 2015 thus far (Figure 5).
Bear in mind that just five days before this historic sell-off began, Mario Draghi claimed to see "no evidence" of a bond market bubble, proving yet again that when it comes to asset bubbles, central bankers are never, ever, capable of identifying them ahead of time, even when they've adopted policies that are explicity aimed at inflating them.