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

LONDON:

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.”

70-YEAR BOND

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