The early stages of the coronavirus shock to markets followed a familiar script: stocks fell hard while the government bonds that investors crave in times of stress shot higher. It was painful for many fund managers but a standard response to the risk of a looming global recession.
But that pattern has begun to break down, with big slides in safe assets at the same time as historic drops in equities. This week that intensified, creating a “sell everything” mindset that stunned industry veterans.
“[It] was mind-boggling,” said Bob Michele, chief investment officer at JPMorgan Asset Management. “I have been doing this now for almost 40 years, and this is the strangest market I have ever seen.” The lack of a reliable asset that rallies in bouts of nerves is unprecedented, he said.
Prices of government bonds, usually financial markets’ ultimate safe harbour and a key reference point for assets across the world, flailed wildly over the past five trading days. They frequently tumbled in tandem with stock markets as investors yanked money out of funds at a record pace and portfolio managers scrambled to sell whatever assets they could.
In the early stages of the pandemic, investors piled into government bonds, pushing the US 10-year Treasury yield to a record low of less than 0.4 per cent on March 9. The reaction was similar across the Atlantic: 10-year yields in Germany, Europe’s ultimate haven, collapsed to an unprecedented minus 1 per cent.
Since hitting those troughs, yields have climbed sharply, a rise that accelerated last week in erratic trading. As investors resigned themselves to a deep global recession, the 10-year Treasury yield peaked at nearly 1.3 per cent on Thursday, with Germany’s equivalent surging to minus 0.2 per cent.
A lot of fund managers had been set for a quiet year of steady returns. Instead, the value of their assets is plunging and many are being forced to hand money back to clients who would rather shelter in the safety of cash deposits.
“The industry as a whole is facing outflows,” said Andrew Wilson, chairman of global fixed income at Goldman Sachs Asset Management. “Our primary responsibility is generating the liquidity our clients want. All of us are having to sell the things we can, rather than the things we would want to sell in a calm market environment. That’s why this ripples right across everything.”
Bond fund managers complain of a lack of liquidity, particularly for riskier corporate bonds, as banks and other trading houses step back from markets. That means many are forced to offload more heavily-traded government debt in order to hand cash back to clients.
Central banks have been compelled to provide backstops for fixed-income markets, which have arrived at dizzying speed. After the Federal Reserve’s announcement of at least $700bn of asset purchases last Sunday failed to calm markets, the European Central Bank followed with €750bn on Wednesday and the Bank of England with £200bn on Thursday.
The recent losses for government bonds have called into question their traditional role in investors’ portfolios, where they typically serve as a counterweight that rallies as riskier assets fall.
“The value as a hedge is just not there,” said Rick Rieder, BlackRock’s chief investment officer of global fixed income. He said he had sold US government bonds over the past two weeks even as stock markets were melting down, judging that there was little potential upside in owning them — but plenty of room for declines.
With the Fed cutting rates to near-zero and relaunching bond purchases, 10-year Treasury yields look attractive based on valuations, but the volatility is off-putting, Mr Rieder said. “Now it makes sense to just own risk assets in smaller sizes and nothing else. The best hedge in our portfolio is cash.”
The world’s largest asset manager is not alone in this dash for liquidity. Investors pulled a record $109bn out of bond funds in the week to Wednesday, according to data from EPFR Global. Money market funds, which invest in cash-like short-term debt, have had record inflows. Treasury bills, which mature in one year or less and are seen as more akin to cash, have been in such high demand that yields turned negative this week.
Despite the recent rises, government borrowing costs in the big developed economies remain low by historical standards — largely thanks to central banks’ efforts. Bonds recovered some of their losses on Friday, although they did so together with a steadying of stock markets. The true test of bond markets’ solidity will come if and when there is a renewed dive in equity markets, analysts say.
One sign of investors’ frayed nerves is that volatility in the US Treasury market implied by options prices remains close to its highest level since 2009, according to an index compiled by Bank of America.
Within the past week, people have seen swings that “statistically speaking, should only happen every few millennia,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott. “Perhaps financial markets are a little broken.”