Investors brace for Bund tantrum 2.0
Markets get thinner
LONDON, Dec 17, (RTRS): Thin market activity that can trigger dramatic price moves is shaping up as a major worry for debt investors next year, as normally staid German government bonds end their most volatile year since 2011.
Hefty buying by central banks and asset managers has choked off liquidity in the world’s biggest bond markets, while tighter regulation has strained banks’ market-making capabilities.
Further, high-frequency, computerdriven trading can create instability. Such trading may increase the volume of transactions, analysts say, but the liquidity can be less predictable than conventional flows.
These conditions, expected to endure next year, mean bond markets remain susceptible to dramatic price moves such as the sell-off in benchmark German bonds that caught investors and policymakers off guard earlier this year.
“When I talk to clients, I tell them I am braced for Bund tantrum 2.0 next year,” ING senior rates strategist Martin Van Vliet said.
The dramatic sell-off in German bonds in the second quarter - the original Bund tantrum - followed global market turbulence in 2013 on speculation U.S. monetary stimulus would end, the so-called taper tantrum.
Barclays rates strategists Cagdas Aksu and Rajiv Setia said that although sovereign bond markets are generally deemed liquid because daily trading volume dwarfs that in other markets, large intraday price moves this year paint a more disturbing picture.
Daily volume in the German bond market is more than 19 billion euros ($20.7 billion), according to Germany’s finance agency. But overall annual volumes in Germany have declined over the past decade to stand at 4.9 trillion euros in 2014 - down a third from 2005.
Central banks buying bonds for monetary stimulus have allowed investors to make big profits. At the same time, though, they have sucked volume out of the market, heightening price volatility.
The average daily move between the highest and lowest price for German Bund futures was about 86 ticks this year, the highest since 2011, Thomson Reuters data shows.
RBS rates strategist Clement MaryDauphin said there have been more volatile events in the Bund market this year than in the recent past and that this was statistically rare.
“We expect this to remain the case next year, because liquidity can disappear,” he said. “The fact that the ECB is buying bonds leaves very few bonds on the table and that is something that is impacting liquidity.”
The ECB on Dec. 3 extended by six months its programme of buying 60 billion euro a month of assets, to March 2017.
The impact of low liquidity was highlighted in April and May when German bonds suffered one of their biggest ever sell-offs, pushing yields up sharply.
Ten-year Bund yields soared from record lows near zero in a matter of weeks, as the view that quantitative easing would hold yields down gave way to a perception that QE would boost inflation faster than expected.
Thin market conditions meant that once the selling got under way, it snowballed.
“It only took a few investors to reposition, given a divergence in the outlook between inflation and the nominal curve, to see yields move markedly higher, forcing other investors to bail out,” said Rabobank senior fixed income strategist Richard McGuire.
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