It’s not the destination that matters, but the journey.
That’s one squib of New Age wisdom that also resonates on trading desks, and helps explain the anxiety being spread by the global selloff in government bonds. Because, after all, even with a week or so of steady liquidation of “safer” government debt, yields are still quite low.
On 10-year notes, the yield in Germany is merely near three-quarters of a percent. In the U.S., the 10-year yield (^TNX) is up near 2.3%, which is only a bit higher than in early March and at year-end. The 30-year Treasury yield (^TYX) darted above 3%, but that’s where it spent the bulk of 2013 and 2014.
These are not levels of interest rates that should present a great challenge, yet, for the real economy. Money is still cheap, the debt markets remain wide open for business for companies and in some ways this is what we wanted: An end to the deflation fears that gripped investors for much of last year. But it’s the suddenness and speed of the journey that took us up to these yield levels that have markets unsettled.
This is why stock markets are in retreat as bond investors throw a tantrum. The quickness and violence of the move up in yield implies too many big institutional investors caught offside and forced to reduce risk levels, which can beget still more selling.
At these times, it becomes a game of trying to figure out if the Big Money is trapped, and where, and then often deciding to just get out of the way, in case it gets even uglier. One useful snapshot of the nastiness of this bond action is the recent descent in the popular long-term Treasury ETF under ticker symbol TLT. The fund – often used in the supposedly “safe” potion of a small investor’s portfolio – has lost more than 13% of its value since Jan. 30 alone.
In these instances, the question of why a sharp market break is happening is somewhat less important than how, and how fast. But it’s worth discussing anyway. In the case of developed-country bonds, inflation expectations have edged up with oil prices, firmer growth levels in Europe and stimulus in China. Too many investors got too confortable with the idea that central banks would keep rates “lower for longer,” as the Fed edges toward its first rate hike in nine years.
And of course, some sage old bond investors such as Bill Gross of Janus made the fairly obvious observation that German 10-year paper near a zero yield offered little value and was better shorted than owned. As for stocks’ adverse reaction, it’s again about the generally unsettled condition of capital markets and risk reduction at work.
Keep in mind that the S&P 500 (^GSPC) had shuttled back to the upper edge of its months-long range, and when that’s happened lately there’s always been some ready excuse for a pullback. And higher yields - without an obvious acceleration in the economy - isn’t the most-welcome combination. The violence of the bond selloff is somewhat like the quicksilver moves in oil and the dollar coming into the year – in isolation they could be handled, but not at that speed.
Which leaves us all monitoring the big auction of U.S. Treasury securities this afternoon, which will be followed by more new supply in coming days. When we get these swirling inter-market reactions among stocks, bonds and currencies, what investors most want to see is for the price moves to slow down and stabilize, as a hint that forced or fearful selling is abating. The credit markets have so far held up pretty well in this wild government-bond move, with demand for high-yield corporate debt firm this week. That’s often a key input for how stocks respond, and it’s not yet telling us to raise the market alert level too high.
But stay tuned - things are moving fast out there.