Bond Prices Start to Fall
Investors sold off European sovereign debt on Wednesday as they started to consider the possibility of higher interest rates come March 2017.
The European Central Bank (ECB) has scheduled an end to its quantitative easing program by the end of the first quarter of 2017, but they haven’t ruled out an extension.
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As a result, markets continue to weigh the possibility that the central bank will taper very soon. (Source: “Government Bond Yields Rise Amid European Pressures,” The Wall Street Journal, October 26, 2016.)
Yields on 10-year German bonds jumped to 0.089% from 0.022% on Tuesday, while Italian bonds spiked to 1.174% from 1.382%. The contagion even spread across the Atlantic, driving 10-year Treasury notes up from 1.758% to 1.783%.
Since yields rise when bond prices fall, it can only be concluded that markets were pulling money out of bonds.
Some analysts think that Tuesday night’s stack of bond issuances may be to blame. There was an abnormal amount of new corporate and government debt put up for sale that night, meaning that investors were just spread too thin across the supply of bonds.
This would explain a short-term dip in bond prices, so analysts are waiting to see if yields continue to rise. A prolonged upward trend would show that investors expect the Federal Reserve to raise interest rates this year, and that they are starting to believe the ECB will follow in kind.
The “tail risk” of an ECB taper would mean that demand for European sovereign would fall, thus leading to exactly the phenomenon that took place this week: rising yields and falling bond prices.
Having it happen preemptively is a dead giveaway as to what the market expects to happen. Analysts are split on whether there is still more room for bond prices to fall, but they should get a definitive answer by the end of December.
It is almost a foregone conclusion that the Fed will raise interest rates this year, meaning any downside risks to bonds will be exposed in the aftermath of that hike.
