Why global bonds are getting sold off

Over the past few weeks, most bond markets have been sold off aggressively. The UK, Japan, the USA and some members of the eurozone have experienced a selloff in between 2 percent to 3 percent. The range of the selloff in prices might not seem big but in value terms the loss might be quite big to bear for bond investors. The selloff might extend into the year end.

There are some reasons for the sudden sell off but the main ones are: bond valuations are far from being realistic and have ignored all the fundamentals. Quantitative measures introduced by some central banks are no longer adding any benefits to their economies and they are actually hurting the banks. Finally, investors have become aware of the above and also aware that governments must use fiscal policies to reflate their economies and generate economic growth. We should always remember that loose fiscal policy and reflation are the real enemies of the bond market.

Although global economic activity is still slow and there is no sign of picking up and inflation is not a threat but bond valuations have stretched too much for the comfort of investors. Negative yields are no longer the solution to stronger economic growth. The deterioration in the future global economic outlook has not been enough reason to justify the massive drop in bond yields throughout the year. If future economic growth in the developed economies reaches historical trend levels with inflation picking up slightly then bond prices could drop further to accommodate realistic valuations.

Central Banks’s Quantitative Measures have been the driving force behind the rise of bond prices and drop in yields. This can be related to the massive scale of bond purchases by central banks. Bonds buying operations has been going on for a quite while particularly in Japan, the Eurozone and the UK. The Bank of Japan and the Bank of England have recently indicated that their Quantitative policies are under review. They are assessing the impact of the massive expansion in the money supply and its impact on the real economy. Like other central banks, they are no realizing that the big drop in bond yields in UK bonds and negative yields in Japanese bonds have led to increases in costs to banks and financial institutions and causing distortions with negative benefits on economic activity.

Global bond investors should expect the European Central Bank to follow the Bank of Japan and the bank of England in announcing some change in its Quantitative Easing guidelines when they meet in December. I think for the time being the ECB is monitoring Japan and the UK to assess and decide how to change it’s or amend its Quantitative Easing policy. The selloff in global bond prices might not be a good sign for them. For the time being bond investors should be very careful not to get into the selloff trap that might go on for a long time.

If the stock market can be any good guide for future expectation of interest rates, then the recent outperformance of cyclical stocks might tell us that fiscal policy might be upcoming. There is at least expectation in the US that with a new president, Treasuries could adopt new policies that create stronger economic growth and reflate prices. The talks in the US is about the possibility of tax cuts measures are linked to the result of the presidential election in November. Investors are more convinced that change in fiscal policies are more effective in increasing domestic demands than Quantitative Measures that have become a burden than benefits.