Fears of a Global Selling Spree Spook Investors in Bond Markets
Posted January 10, 2018 8:36 p.m. EST
For nearly a decade, central banks around the world have been the biggest buyers of bonds, sending interest rates plummeting and stock markets soaring.
Now, investors are starting to worry about what would happen if the richest nations start to scale back on a buying binge that most of them began to stimulate economies hurt by the global financial crisis.
The most immediate fear: A sharp falloff in bond prices would rattle equity markets that are now trading at record highs. Beyond that, there is a looming concern that as the global economy heats up, inflation, a bond investor’s main worry, will start to inch up, fed by higher wage demands on the part of workers everywhere.
“Your largest investor might be stepping back, that’s what spooked people,” said John Briggs, a bond strategist at NatWest Markets. “The market is very vulnerable to any change in supply and demand.”
That vulnerability has been on display in recent weeks, with many investors selling out of their bond positions, pushing the yield — which rises as bond prices fall — on the benchmark 10-year U.S. Treasury bill up to a high of 2.59 percent on Wednesday from 2.3 percent late last year.
Bond markets appeared to be further spooked on Wednesday by a report that China’s central bank, which owns $1.2 trillion in U.S. Treasury bonds, may be poised to slow or even halt its buying of U.S. debt. China has total reserves of just over $3 trillion.
Yields on 10-year Treasury notes climbed in early trading, and the dollar weakened at the prospect of lessened demand tied to a selling of U.S. bonds by a large holder like China. The rising yields led Bill Gross of Janus Henderson, whose renown as a bond investor came to define the multidecade bull market for fixed-income securities, to pronounce the start of a bear market for bonds, although he said on Wednesday that he did not foresee drastic losses.
So far, China has made no official statement on its plans for its U.S. Treasurys. Analysts do not believe that the country, which under President Xi Jinping has taken pride in its standing as an elite member of the club of wealthy nations, would rashly unload the securities it has amassed over the years.
Not only would such a step hurt China by decreasing the value of its bond holdings, it would wreak havoc in a global economy that the country is now fully integrated into through deep trade and financial links.
To some experts, a move by China to pull back on its bond-buying could simply be seen as responsible-reserve management by one of the world’s richest central banks. “The boring explanation here is that China just has enough Treasurys in its portfolio,” said Brad Setser, an expert in global capital flows at the Council on Foreign Relations.
But there is another interpretation that gets at the simmering tensions between the United States and China over North Korea and trade. “It is possible too that China wants to signal to its people that it will not keep financing the U.S. when the U.S. is not treating China with respect,” Setser said.
There is also a belief among many economists that the tax cuts recently signed into law by President Donald Trump could worsen the United States’ financial position and make its debt less attractive as an investment.
For now, investors appear to have accepted the benign view. Major stock indexes in the United States were down only slightly on Wednesday, and the VIX index, which measures investor expectations of a sharp market move in the future, remained just over 10, a very low level.
Nevertheless, the mere thought that China might choose to unload some of its Treasurys fed broader concerns about how the markets react as central banks in the United States, Japan and Europe normalize policies adopted to prop up faltering economies.
All told, the three central banks are sitting on $14 trillion in securities they have bought since 2009: a $4.4 trillion mix of Treasurys and mortgage securities held by the Federal Reserve; the European Central Bank’s $5 trillion in corporate and government bonds; and $4.5 trillion worth of bonds and exchange traded funds accumulated by the Bank of Japan.
Moreover, the view that the U.S. government, in the wake of the tax cut package, will have to issue more securities to finance a larger budget deficit is giving bond investors pause.
“The U.S. is about to issue a whole lot more debt in an environment where the demand for that debt is about to go down,” said Daniel W. Drezner, a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University. “What that means is interest rates are about to go up.”
And that is bad news for bond investors.