- A major global bond rally has been driven by asset re-positioning and technical factors as US stocks continue to fall.
- Australian 10-year government bond yields have now fallen by around 30 basis points since mid-February.
- Despite the recent demand, analysts expect bond yields to continue rising in 2018.
The risk-off tone in global markets overnight was punctuated by a sharp rally in global bonds.
Bonds are typically seen as a safe-haven investment when other markets, particularly stocks, are under pressure.
And US stock volatility is on the rise. Markets rallied on Monday night in the wake of last week’s selling amid threats of a US-China trade war.
But those gains were wiped out last night, led by a sharp selloff in tech stocks as the index which tracks the biggest US tech companies had its biggest one-day drop in three years.
At the same time, demand for bonds saw benchmark US 10-year yields fall by more than 6 basis points to a six-week low of around 2.78%.
Commonwealth Bank’s Head of Fixed Income Research Adam Donaldson said technical factors played a role in last night’s price action.
“The yield on US 10-years fell through the 2.8% level — which took them back below the 50-day moving average,” Donaldson told Business Insider.
“So the technical indicators suggest a break through key support levels, which in turn helped to drive further demand.”
But Donaldson said the move was also a clear response to increased nervousness elsewhere
“This period of stabilisation does partly reflect the wobbles in other markets, with equities under pressure,” he said.
ANZ senior rates strategist Martin Whetton agreed that last night’s price action was representative of a normal shift in capital flows.
“It’s hard to say there was demand for bonds — over and above what normally transpires,” Whetton told BI.
“Volume was normal, but equities took it in the neck, so bonds rallied.”
DailyFX senior strategist Ilya Spivak explained the move as “a typical risk-off rotation into bonds”.
Along with the move in US 10-years, Australian 10-year bond yields fell just as sharply overnight and are now sitting just above 2.6%:
At that level, the yield spread on Aussie-US 10-years is currently around negative 17 basis points, after falling below parity earlier this year for the first time since 2000.
“For international investors, Australia still looks like a good defensive place to park your money,” Donaldson said, citing three main factors.
“Australia’s very strong fiscal position, limited bond supply and a low inflation outlook are combining to drive that demand.”
In a research note yesterday, Whetton’s research team at ANZ said the “symbolic shift” in the yield spread had led to a reduction in offshore demand.
“Indeed, the fall in hedging costs has opened the market to a new set of investors,” the analysts wrote.
So where to from here for bonds?
Spivak told Business Insider that when it comes to the direction of bond yields, “the reason for risk aversion matters”.
“If it’s driven by worries that the Fed tightening will accelerate, stocks and bonds can fall in tandem because rising yields are the reason for the turmoil,” Spivak said.
“But if risk aversion is driven by trade wars or geopolitical jitters, then that is a threat to growth.”
“That weighs against the corporate earnings outlook and brings stocks lower which makes bonds a haven play and in that scenario, yields fall.”
Despite last night’s rally, ANZ holds the view that bond yields will continue to push higher over the course of the year.
“Markets now face a world where government bond issuance surpasses central bank buying. A world where growth may have peaked but remains solid. A market that has gone too far with low yields, flat curves, tight spreads and no risk premium.”
“This situation will unwind, but the risk is that it happens faster than is expected.”