Global government-bond markets are stuck in what BofA Securities analysts are calling one of the greatest bear markets ever and this is in turn threatening the ease with which investors will be able to exit from the world’s most-crowded trades, if needed.
Those trades include positions in the dollar, U.S. technology companies and private equity, said BofA strategists Michael Hartnett, Elyas Galou, and Myung-Jee Jung. Bonds are generally regarded as one of the most liquid asset classes available to investors. If liquidity dries up in that market, it’s bad news for just about every other form of investment, other analysts said.
Financial markets have yet to price in the worst-case outcomes for inflation, interest rates, and the economy around the world, despite tumbling global equities along with a selloff of bonds in the U.S. and the U.K. On Friday, the Dow industrials
sank almost 500 points and flirted with a fall into bear-market territory, while the S&P 500 index
stopped short of ending the New York session below its June closing low.
U.S. bond yields are at or near multiyear highs. Meanwhile, government-bond yields in the U.K., Germany, and France have risen at the fastest clip since the 1990s, according to BofA Securities.
“Inflation/rates/recession shocks are not over, plus the bond crash in recent weeks, means the highs in credit spreads and lows in stocks are not yet in,” the BofA strategists wrote in a note released Thursday. They said investor sentiment is “unquestionably” the worst since the 2007-2009 global financial crisis. The analysts also see the fed-funds rate target, Treasury yields, and the U.S. unemployment rate all heading to between 4% and 5% over coming months and quarters.
Government bonds have racked up losses of 20% so far in 2022, as of Thursday, according to BofA. They are on course this year for one of their worst performances since the Treaty of Versailles, which was signed in 1919 and went into effect in 1920, establishing the terms for peace at the end of World War I.
Source: BofA Global Investment Strategy, Bloomberg
Liquidity in markets matters because it ensures that assets can be bought or sold without significantly impacting the price of that security. Without liquidity, it’s harder to convert an asset into cash without losing money as the price moves.
Government bonds are the world’s most liquid asset so “if the bond market does not function, then no other market functions, really,” said Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York.
“Rising yields continue to dry up credit and are going to hit the global economy hard,” Emons said via phone on Friday. “There’s a risk of a ‘sell-everything market’ that would resemble March 2020, as people withdraw from markets amid greater volatility and find they cannot actually trade.”
A historic bond selloff in the U.K. on Friday, triggered by eroding investor confidence fueled by the government’s mini-budget plan, only exacerbated fears about worsening liquidity, particularly in the ordinarily safe U.S. Treasury market.
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In the U.S., Federal Reserve officials have shown a willingness to break something by raising interest rates quickly —whether it be in financial markets or the economy — to bring down the hottest inflation spell of the past 40 years.
Part of this month’s retreat in global bond prices and rising yields “is the real fear that central bank hikes spiral upward in a competitive race to maintain currency viability and not to become the last country holding the bag of runaway inflation,” said Jim Vogel, an executive vice president at FHN Financial in Memphis.