Business World

Wednesday 21 February 2018

Bond market €300bn crash may be ending

Pensions funds hit by sell off

Standard Life, which oversees $488bn, has maintained a
Standard Life, which oversees $488bn, has maintained a "heavy' or overweight position on European bonds, according to Hudson

Anchalee Worrachate and Tanvir Sandhu

The great European bond sell-off of 2015 that erased $300bn from the market has run its course, at least according to options prices on German bond futures. Irish pension funds have been hit hard as they hold large numbers of bonds.

Traders are the least bearish on Europe's benchmark sovereign securities since the plunge started. They're paying almost the same for derivatives granting the right to buy German bund futures, or calls, as to sell them over the next month using puts.

The turnabout took hold in Europe as oil prices fell, undercutting concern that higher inflation would erode bond prices. While inflation fears only two weeks earlier had sparked a rout in fixed-income markets on several continents, perceptions were changing. Then European Central Bank policy makers on Tuesday said they would speed purchases of debt in their $1.2trn quantitative easing plan, widening the safety net for the region's $6trn of sovereign securities.

"That bullish comment by the ECB took the cat away from the pigeons," said Richard McGuire, head of European rates strategy at Rabobank International in London. "Some investors we talked to said they were monitoring the sell-off with an eye to possible re-initiation of long positions," he said, referring to bets that asset prices will rise.

A greater degree of stability in the bond market as the sell-off dissipates may create a virtuous circle, allowing buyers scarred by the sell-off to return. That in turn would enable companies and governments to raise funds in the debt market with greater confidence that the cost of borrowing won't be distorted by exaggerated price gyrations.

The premium for puts over calls on what is Europe's bond bellwether shrunk to as little as 0.40 percentage point last week, the smallest on a closing basis since bunds and bund futures began their plunge on April 29. The spread was as high as 1.78 percentage point on May 13. The closing-market yield on 10-year German government bonds jumped to as high as 0.72pc from 0.075pc in the space of less than a month during the rout. A separate gauge of investor bias also showed bears in retreat. A put-call ratio, or proportion of outstanding puts to calls on the benchmark German bund future, dropped to 0.63 last Tuesday, the lowest since November.

"We are told the economy should be reflating toward the end of the year, and the sell-off was partly driven by people scaling back on deflation risk," said Frances Hudson, a strategist at Standard Life Investments in Edinburgh. "But in Europe, there is no strong evidence where growth will be coming from. Any increase in yields from here could be hampered by economic uncertainty and ECB action."

Standard Life, which oversees $488bn, has maintained a "heavy' or overweight position on European bonds, according to Hudson. (Bloomberg)

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