Gov­ern­ment bonds may no longer be ‘safe’ as­sets, in­vestors warn

Kuwait Times - - BUSINESS -


In­vestors pushed into buy­ing gov­ern­ment bonds that won’t ma­ture for many years, seek­ing to bol­ster mea­gre re­turns since the fi­nan­cial cri­sis, could now face big losses if cen­tral banks raise in­ter­est rates.

As yields have col­lapsed to­ward zero due to slow economic growth, fall­ing in­fla­tion, su­per-easy mone­tary pol­icy and cen­tral bank bond-buy­ing, in­vestors have sought bonds with longer and longer ma­tu­ri­ties to eke out ex­tra ba­sis points in re­turn.

Gov­ern­ments keen to lock in record-low bor­row­ing rates have obliged by is­su­ing longer and longer debt. A spate of 30-year and 50-year is­suances have seen av­er­age ma­tu­ri­ties rise to 9.8 years, from 8.5 in 2011, ac­cord­ing to JP Mor­gan’s global gov­ern­ment bond in­dex - a huge shift for the multi-tril­lion dol­lar market. How­ever if cen­tral banks raise rates to boost growth, bond prices will fall, with longer-dated ones sink­ing more sharply.

This could trig­ger a sell-off that could be as bad or worse than the 2013 market rout - the “taper tantrum” when the US Fed­eral Re­serve be­gan ta­per­ing its mas­sive bond-buy­ing pro­gram, ac­cord­ing to fund man­agers. At least one ma­jor cen­tral bank - the Fed - is im­mi­nently look­ing to raise rates and oth­ers in Ja­pan and Euro­pean coun­tries, in­clud­ing the Euro­pean Cen­tral Bank and the Bank of Eng­land, are look­ing at ways to tighten pol­icy.

This un­der­mines the sta­tus of gov­ern­ment bonds as “safe haven” as­sets, and leaves tra­di­tion­ally con­ser­va­tive pen­sion, en­dow­ment and in­sur­ance funds loaded with “safe” bonds that now face huge cap­i­tal losses if in­ter­est rates do in­deed turn. “It will be much worse than the taper tantrum in the US,” said Louis Gar­gour, chief in­vest­ment of­fi­cer at London-based credit hedge fund LNG Cap­i­tal. “That move was caused by the an­tic­i­pa­tion of rates go­ing higher. Now the re­al­ity is set­ting in and the cy­cle has changed and the market is done. I think the ef­fect will be sig­nif­i­cantly more dra­matic.”


Longer-dated bonds typ­i­cally have a higher “du­ra­tion” - a cal­cu­la­tion used to de­ter­mine how long it takes to re­coup your orig­i­nal in­vest­ment via an­nual coupons which makes their prices far more sen­si­tive to an in­ter­est rate hike. The av­er­age du­ra­tion of global bond port­fo­lios is at a record high of seven years, from five years in 2008, In­ter­na­tional Mone­tary Fund data. This comes at a time when de­mand for bonds has grown more than any other as­set class - by $410 bil­lion this year alone, Lip­per data shows.

The stretch­ing of the so-called du­ra­tion of many funds’ bond port­fo­lios around the world shows how vul­ner­a­ble the as­sets are to a se­vere crash. “The pos­si­bil­ity of a sharp rise in in­ter­est rates (caus­ing a re­ac­tion) akin to the pre­vi­ous taper tantrum is a sce­nario we are highly fo­cused on,” said Kath­leen Hughes, head of Euro­pean in­sti­tu­tional sales at Gold­man Sachs As­set Man­age­ment. —Reuters

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